A Very Strong 2019 Should Get Even Better
Here we are well into the fourth quarter of 2019, one of the strongest years for equities in the past 20 years (2013 better). In other words, this is the best year for stocks in a typical career.
As we head into year end, I’m raising my S&P year-end target to 3,185 (+60 points). This is based on $182 EPS (+$2 above consensus) and 17.5x PE (+0.4x above current). The PE works out to a 5.8 % earnings yield compared to an investment grade bond yield of 3.0%. Thus, one could even view stocks as cheap vs credit (same issuer).
In looking back at how we got to this point, the consensus focus has been on the many “tape bombs” that “threatened the cycle.” This includes Trump “ordering all companies home” to Fed stating rates were a “long way from Neutral” to the hard Brexit and inverted yield curves.
But I would argue these concerns were the wrong way to understand markets this year.
2019 is actually a “catch-up year.” Since 2017, EPS grew at 11% annually on average, but price gains were only 7%. Hence, stocks still have room to rise.
In fact, from the beginning of the year markets were signaling a strong year was ahead.
How? Well, my evidence-based framework told me at the start of 2019, that 2009 was the best analog for 2019. While it seemed crazy at the time, the trifecta (of 9 factors) was (i) a waterfall decline in stocks; (ii) HY signal based on poor performance in the prior year and (iii) the Fed’s dovish turn. These things only happened together in 2009 and thus, I saw 2019 as a 25% gain kind of year.
But wait, there’s more!
ISM exports also ticked above 50 in October, after two months of “recession-like” readings of 43.3 and 41.0 (Aug/Sep). Since 1993, inflections in ISM exports have led to 545 basis points of acceleration in EPS growth YoY. This is logical because it signals a revival of growth (in this case, industrial cycle). Hence, we think consensus 2020 EPS of $180 will be revised upwards. We are $2 above consensus.
And finally, we are in the final 8 weeks of 2019, which is roughly the start of the Santa Claus rally. This effect is very strong in the last 20 years. Since 1998, when the S&P 500 is up at least 9.5% from Jan 1 through Nov 7, the average gain through year-end is 4% (n=10). 10 of 10 times (100%), S&P rose in the final 8 weeks. Based on this math, the implied S&P 500 finish is 3,212.
What could go wrong? The biggest risk, in my view, remains an external shock. The obvious risk remains trade war escalation as well as Brexit. But the offset remains positioning is so conservative, that a crisis is more “priced in” than “industrial cycle bottoming.”
Bottom line: We think history shows that investors should be risk-on into year-end. We believe S&P 500 has 100-120 points upside into year-end. Some of this may be borrowing from 1Q2020 given the expansion of valuation. We continue to use same cyclical list for YE rally. The tickets are: TPR, KSS, LEN, PHM, EXPE, LMT, CAT, CMI, EMR, ROK, IBM, INTC, MXIM, QCOM, QRVO, PLD, CBRE, CCI, IRM, SBAC, CTL, DISCK, T, ATVI and VIAB.
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