Here we are again! 2018 is in the bag and we’re all wondering what 2019 is going to look like. There is a tendency for some people to focus on "what's happened lately" when evaluating or predicting something (Recency Bias). Given the last quarter of 2018, we tend to think this is the way it could be moving forward.
Let’s Recap Our Expectations for Last Year
We anticipated the stock market (Dow Jones Industrial Average) would finish 2018 at 28,500. The Dow finished at 23,337. We were off by 18%. However, there is more to this story... The 2018 trend line (below) shows that we were on track for approximately 27,000 but dropped in the 4th quarter.
The question becomes, has the underlying economy or expectations for the future economy changed? We will address this and What to expect moving forward but, first...
In January of Last Year We Anticipated The Economy Would Perform as Follows:
- Gross Domestic Product (GDP) Would Be 3% for 2018,
- Inflation Would Be 2.5%
- Unemployment Rate Would Drop to 3.7%
- The Federal Reserve Would Raise Interest Rates 3 Times
As of Year-End 2018, the Following Occurred:
- GDP Numbers For The 4th Quarter Are Not In Yet, But 2018 Will Likely End Up With GDP Growth of 3%
- Inflation Was 2%, Lower Than Expected Primarily Due To The Steep Drop In The Price Of Oil
- Unemployment Rate Ended The Year At 3.9%, Higher Than Expected Due To An Increase In The Labor Participation Rate In December (more people were looking for jobs)
- The Fed Raised Interest Rates 4 Times
We seem to have pegged the economy pretty closely.
What Do We Expect The Economy To Do In 2019?
- GDP Consensus Expectations Of 2.6%
- Inflation Of 2.5%, Assuming Oil Prices Normalize
- Unemployment 3.4%
- The Federal Reserve Will Raise Interest Rates 2 Times
According to USA Today [https://www.usatoday.com/story/money/2018/12/24/stock-market-forecast-2019/2390483002] the average prediction is for a hefty gain of 25 percent in the S&P 500 next year, according to Bloomberg, citing year-end forecasts from stock pros at 19 Wall Street banks. That puts the market at about 28,000. The most optimistic is Deutsche Bank at 30,000 and the least optimistic is Morgan Stanley at 25,400.
According to the same article, after the worst December since 1931 and the worst year since the 2008 financial crisis, the US stock market’s price-to-earnings ratio – which shows how much investors are willing to pay per dollar of profits – has fallen from its peak of 18.5 times earnings at the end of 2017 to a low of around 15 times at the end of October. In other words, the markets are cheap relative to a year ago.
That’s not to say that we won’t have volatility. WE WILL! Last year had two corrections of 10% or more. We are in the era of programmed trading (computers determining when to buy and sell https://money.cnn.com/2018/02/06/investing/wall-street-computers-program-trading/index.html ) and news driven markets. Bad news sells newspapers and cable TV shows, and news can drive markets up or down, dramatically, the majority of which is negative. This tends to overshadow the fundamental economic data, which is overwhelmingly positive.
I believe the 4th quarter market drop was irrational.
An old Wall Street saying comes to mind……, “Markets can remain irrational longer than you can remain solvent” (Originally credited to John Maynard Keynes, but now disputed)
Risks to Our Expectations:
- The Federal Reserve can increase interest rates too quickly, leading to a recession.
- The trade “wars”, which are moving in our direction, could get out of hand, slowing global growth. (Nonetheless, China has been reducing tariffs on US products sold in China by 23% in 2018. http://fortune.com/2018/10/01/china-import-tariffs-cut-trump-trade-war/)
- Geopolitical Risks. Brexit in England, Italy’s budget deficits stoking a protracted fight with the European Union. We can include Russia and China’s arms buildups. Additionally, our own fractured political environment.
- Politics dominated the headlines, but earnings drive the market. With corporate earnings up over 20% last year, they could drop by half. That doesn’t spell doom for the markets, earnings are still growing. Think of it this way, say you are driving down the freeway at 75 miles an hour. You let up on the gas, and slow down…. you’re still moving…in the direction you wanted to go. Earnings should still drive the market up, but at a slower rate, and that could keep the markets from reaching the market highs we are projecting.
- Fear of recession (a significant decline in economic activity spread across the economy, lasting more than a few months). Recessions are normally associated with high inflation, which we are not seeing or project to see in the next year. However, recessions are also the normal outcome of an “over heated” economy, which we see few signs today. BlackRock puts the risk of recession at 19% for 2019, 38% for 2020 and 54% for 2021.
- We are in the longest bull market in history, defined as market growth without a 20% correction. The second longest bull market was 1990 to 2000. That market was up over 400%. Our current market is up just under 300% since 2009, the start of the current bull. It’s not the largest bull market, but it is the longest. We’re in uncharted territories….it can’t go up for ever.
With all this data, the bottom line is the economy and markets should continue to grow. The economy grew nicely in 2018, but the markets did not. 2019 could be the year that the markets catch up with the economy.
At MPB Wealth Management we will continue to make slight adjustments to our models as markets and fundamentals evolve. Our focus for 2019 is to reduce “downside participation” in our models, in other words, limit losses when markets experience major drops. Protecting the downside can also mean giving up some of the up side.
Each of our clients have a unique fact pattern: risk tolerance, time frame, required returns and financial needs. Our business model has always been to continue to measure and weigh all options with the client. We hope clients are educated and confident they are in the right model (emotionally and financially). Our clients needs simply come first. Anxiety is high and markets are volatile. We ask you to keep your eye on the long term and continue to stay on track with your Annual Reviews where we can continue to earn your trust.
I thought you would enjoy the following graph comparing consensus Wall Street strategists’ average market performance projections to actual market performance.
“Economists are about as useful as astrologers in predicting the future….and like astrologers, they never let failure on one occasion diminish certitude on the next”Arthur M. Schlesinger, Jr
Michael Phillips Black, CFP®, CDFA®, and AIF®, Sole-Proprietor of MPB Wealth Management A Professional Planning Association; is an Investment Advisor Representative of Investment Advisors, is a Registered Investment Advisor and a Division of ProEquities, Inc.,a Registered Broker-Dealer, Member, FINRA & SIPC.