Almost exactly one year ago today, the stock market was tumbling and on December 24, 2018 was set to post its first 20% "bear market" correction since the financial crisis. However, not even the most jittery market since the financial crisis, one which saw virtually every major asset class post sharply negative returns, managed to sap the sellside analyst crew of its traditional optimism.
As a reminder, at the start of December 2018 Bloomberg calculated that of the 14 forecasts for 2019 from firms it tracks, the average prediction was for the S&P 500 to rise 11% to 3,056 by the end of 2019. And while the steepness of the forecast path reflected the recent damage done to stocks, it was the most optimistic call since the bull market began in 2009.
In retrospect, three Fed rate cuts later, the launch of QE4...
... the fastest expansion of the Fed's Balance sheet since the financial crisis...
... and the most aggressive rate cuts by central banks since the financial ctisis...
... and Wall Street's optimism one year ago turned out to be too conservative, with the S&P now trading at an all time high of 3,150, almost 100 points above the average year-forward S&P forecast one year ago of 3,056.
And to think it only took a crisis-like response by central banks to achieve it.
So what happens next year? Well, this is the strange part, because whereas Wall Street was euphorically bullish one year ago even as stocks were tumbling, this time with the S&P up 25% for the year (the best annual performance since 2013) even Wall Street's most reliable optimists are starting to sound like cranks, as Bloomberg's Lu Wang points out.
Take Binky Chadha, Deutsche Bank's chief global strategist, who one year ago was among the most optimistic of sellside analysts as he saw the S&P 500 rising to 3,250 this year - the highest of anyone tracked by Bloomberg - and yet who now expects the S&P to do absolutely nothing in the coming year. Why? Because according to Chadha, the market has already priced in a strong rebound in macro and earnings growth, "back up to the peaks of this cycle, much stronger than we expect."
Chadha's pessimism reduces to the following sequence of numbers, in which the final number is a clear outlier:
What are these numbers?
Well, after a decade of forecasting large double digit returns in the S&P 500 in his year ahead outlooks, Deutsche Bank's chief equity strategist Binky is finally expecting a flat market, or a 0% return for all of 2020, as his 2019 and 2020 S&P estimates are the same, or 3,250 (technically, Chadha expects a 3.3% return to the end of 2020 from current levels). While we will present some more from Chadha's forecast in a subsequent post as it touches on some key market fundamentals, this is why one of the formerly most bullish Wall Street analysts expects a largely disappointing sideways market next year:
We see EPS of $175; a multiple of 18.5x; and set a 2020 year-end target for the S&P 500 of 3250. This would represent a very modest increase (+3.5%) from last week’s close. Indeed it is the same as our target for 2019, which if achieved by this year-end, would imply a sideways market in 2020. Both a maintenance of the 10-year trend channel of the S&P 500 (+10% to the bottom in end 2020; +23% to the middle), and our demand-supply framework (+10%) with lower but still robust buybacks, could be used to argue for much stronger returns. But we see the market already pricing in a strong rebound in macro- (ISM 57) and earnings growth (+15%), back up to the peaks of this cycle, much stronger than we expect. Equity valuations (19.1x) are at the high end of their historical range (mostly 10x-20x), having been higher (ex the late 1990s equity bubble) only 10% of the time over the last 85 years, while a continued normalization of payout ratios argues for a modest de-rating. The US presidential election should make it difficult for the fundamental uncertainty emanating from US trade policy, which has plagued corporates and been a key driver of the US and global growth slowdowns, to dissipate completely. This argues for a break in the downward trajectory of growth and some bounce, not a rebound to the peaks of this cycle as the market is pricing. With key measures of CEO confidence down at recession levels, we see the risks to the outlook as being to the down side.
Of course, that "other" reason for the surge in stocks, the record stock buybacks - which is how corporate management teams translated the world's ultra low interest rates into higher stock prices by way of record BBB-rated debt issuance - is also starting to fade, which only substantiates Chadha's skeptical outlook.
What is remarkable is that Chadha is hardly the sole bull turned bear on the year ahead: as Bloomberg calculates, the Deutsche Banker's skepticism is the prevailing sentiment as Wall Street strategists are giving the least optimistic annual outlook in 15 years, with an average call among 17 estimates being for the S&P 500 to end next year at 3,280. As of Friday's close, that represents a 4.3% expected increase, the smallest for any year since 2004.
Chadha key concerns for the coming year - summarized above - also happen to be the reason why so many traditionally cheerful strategists are far more pessimistic this time around:
- Pulling returns from the future: the market's impressive rise in 2019 has reduced the size of the advance analysts see in 2020.
- Strategists are concerned about the relatively anemic earnings growth upon which this year’s rally is based. As we noted repeatedly in the past, and as Goldman stated two weeks ago, all of this year’s gains are the result of multiple expansions and wider valuations, a trend few see continuing. As a reminder, this is what Goldman said in its 2020 year ahead forecast: "With S&P 500 earnings on track for roughly zero growth from this time last year, solid returns likely would not have been possible without central bank support." As of this moment, consensus is that central banks won't be nearly as generous as they were in 2019, although all that would be required to change this is another 10%-20% drop in the S&P.
Here it is worth recalling that while strategists can be more or less optimistic any one year, they will never - as a group - call for a lower market in the year ahead. Indeed, as Bloomberg notes, "analysts have never called for a down year in the period Bloomberg has tracked them." Which is why the notable step down in the 2020 forecast is remarkable; meanwhile, those optimists who see the remarkable rally of 2019 continuing are in for disappointment, as "betting on a repeat of 2019 would be a mistake, considering such key risk factors next year as the U.S. presidential elections and a re-escalation of trade tensions."
Even more remarkable, at least three strategists expect the S&P to be lower in 2020 compared to Dec. 31, 2019. Among them are the now traditional bears, such as Morgan Stanley's Mike Wilson and UBS' Francois Trahan, both of whom have a year-end target of 3,000, while Sophie Huynh at Societe Generale has 3,050.
Meanwhile, there are fewer surprises on the bullish side where Bloomberg notes that for the second year in a row, Jonathan Golub at Credit Suisse has the highest sellside forecast, with a 3,425 target on the S&P: "Citing an improving earnings outlook and relatively attractive valuations, Golub says it’s too early to bail even with the record-long bull market heading toward its 12th year."
That said, at 19.1x trailing earnings, the S&P 500 is trading at a multiple that’s higher than any time since the dot-com era, except for a few months in late 2017 and early 2018. As Chadha writes, "the S&P 500 trailing multiple has historically mostly stayed in a range between 10x-20x. So current valuation at 19.1x is clearly at the higher end of the historical range. Indeed, over the last 85 years, outside the late 1990s equity bubble, the multiple remained below current levels around 90% of the time. Moreover, episodes when the multiple did rise above current levels were often associated with markets exiting recessions as stock prices rose sharply in anticipation of a recovery in earnings that was still to materialize."
Still, as Bloomberg notes, with the Federal Reserve in an easing mode and Treasury yields hovering near record lows, stocks can continue rising as multiples expand ever more into excessively over-valued territory.
On the other hand, the only other time all three central banks were easing at the same time as they are now, was during the financial crisis:
As such, it will be difficult to keep injecting hundreds of billions of freshly "printed" liquidity into the market without someone finally asking if the global economy finds itself in another crisis right now to justify such a massive liquidity euphoria.
Which brings up one final question: what happened when Wall Street Strategists were as bearish as they are now, and forecast gains of 5% or less? Well, in 2014 and 2017, they ended up under-shooting by at least 7% points according to Bloomberg, and in 2005, they were right on target.
“It’s important to understand what the consensus is,” said Palisade Capital CIO Dan Veru. "Expectations are very low. I always want to take the other side of that." It wasn't exactly clear if the "other side" of that is to expect a negative return for 2020, or for the liquidity gusher to turn into a tsunami as the world careens into a global depression and stocks explode in one final, record meltup...