Market
Commentary : January 20 2020
In our previous post in mid-November 2019 we had analyzed
the behavior of the S&P 500 Index for the past five years. Subsequent to
that post the Bull Market kept going forward with index making new highs. It
ended the year 3,230.78 for an
impressive gain of 28.9% for 2019.
Naturally the question raised was what will be the
returns in 2020 ?
The futility of predictions or forecasting has never
inhibited Wall Street or weather forecasters from doing it. One recalls the
wise words of the 6th century BC Chinese poet Lao Tsu … "Those who have knowledge, don't
predict. Those who predict, don't have knowledge. "
Nevertheless since we don’t make predictions let us try
to visualize a few scenarios which may occur not necessarily with the same level of
probability.
Scenario 1 (Baseline) :
From a purists point of view the value of the index or a
stock is a function of two variables … the Earnings Per Share multiplied by its
Price to Earnings Ratio. In other words EPS*PE will give an estimate of the
likely price of the stock or value of the index.
The year 2019 saw the S&P-500 Index end at 3,230.78 with
operating earnings estimated at $158.03 per share. This gives us a PE ratio of
20.44 based on the previous two figures.
Analysts estimates for the year 2020 for S&P 500
Earnings Per Share is expected to be $175.16 .
Assuming market participants have the same level of risk
appetite as estimated by the PE ratio of 20.44, we can multiply the two numbers
to arrive that S&P-500 Index is likely to end 2020 at a value of
3,580.99.
As per this scenario assuming that all estimates pan out
as expected and investing risk appetites remain constant, we can expect a
growth of 10.8% on the S&P-500 Index.
Scenario 2 (Earnings Disappointments) :
Given the trend that estimates tend to have an upward
bias especially at the beginning of the year; it makes sense to consider the
case that there is shortfall of earnings to the tune of 5% from the optimistic
estimate levels. Thus we arrive at an adjusted estimate of earnings at $166.40
per share.
Again assuming there is no change in risk appetites the S&P-500
Index is likely to end 2020 at 3,401.94. Thus it would mean a growth of
5.3% for the year 2020.
Scenario 3 (Risk Appetite Wanes):
In this scenario we consider where risk appetites of
investors gets adjusted downwards and are not willing to pay the same levels as
the previous year; it makes sense to evaluate the case where the PE ratios are
reduced by 10% from the current levels of 20.44 to 18.40.
In such a reduced risk appetite environment assuming that
earnings estimates remain unchanged of $175.16 dollars the S&P-500 Index
is likely to end at 3,222.89. This would mean a marginal loss of 0.2%
for the year.
Scenario 4 (Earnings Disappointments &
Risk Appetite Wanes):
In this Scenario we consider the case where both risk
appetites wane and earnings disappointments occur.
In such a Scenario the S&P-500 is likely to end at
3,061.75 for a loss of 5.3% for the year
2020.
Table-1 …
Summary of S&P-500 Performance Scenarios
Earnings Estimate
|
PE Ratio
|
S&P-500 Projected
|
Return%
|
|
1.Baseline
|
$175.16
|
20.44
|
3,580.99
|
10.8%
|
2.EPS Off
|
$166.40
|
20.44
|
3,401.94
|
5.3%
|
3.Risk Off
|
$175.16
|
18.40
|
3,222.89
|
-0.2%
|
4.EPS & Risk Off
|
$166.40
|
18.40
|
3,061.75
|
-8.0%
|
From the above table we can expect a
value somewhere between Scenario-1 and Scenario-2 around 8%, assuming
earnings estimates are not dampened too much and risk appetites continue to be healthy.
Scenario-5 (Presidential Re-Election Years):
Another anecdotal way to look at the whole estimation
game is to find out what were the returns of the S&P-500 during Presidential
Re-Election Years. Though past
performance is no guarantee of future results, purely from a curiosity
standpoint it will be interesting to see how the Stock Market behaved during the 4th year of a newly elected President who is running for re-election.
Table-2 … Performance During Presidential
Re-Election Years
Year-1
|
Year-2
|
Year-3
|
Year-4
|
||
Obama
|
2008
|
23.5%
|
12.8%
|
0.0%
|
13.4%
|
Bush
|
2000
|
-13.0%
|
-23.4%
|
26.4%
|
9.0%
|
Clinton
|
1992
|
7.1%
|
-1.5%
|
34.1%
|
20.3%
|
Bush
|
1988
|
27.3%
|
-6.6%
|
26.3%
|
4.5%
|
Reagan
|
1980
|
-9.7%
|
14.8%
|
17.3%
|
1.4%
|
Carter
|
1976
|
-11.5%
|
1.1%
|
12.3%
|
25.8%
|
Nixon
|
1968
|
-11.4%
|
0.1%
|
10.8%
|
15.6%
|
Eisenhower
|
1956
|
-6.6%
|
45.0%
|
26.4%
|
2.6%
|
Median
|
11.2%
|
||||
Average
|
11.6%
|
It’s clear that there has never been a negative year during
a Presidential Re-Election Year with a median return of 11.2%. In certain cases
like Bill Clinton the Re-Election Year followed up a banner 3rd year
with an above average performance. It remains to be seen which of the above
approximates the performance in 2020.
Whatever be the method used in forecasting especially of
the stock market, it is a fool’s errand or an exercise in vain most of the
time. As Jason Zweig most aptly defines Forecasting in his book “The Devil’s
Financial Dictionary” … The attempt to
predict the unknowable by measuring the irrelevant; a task that, in one way or
another, employs most people on Wall Street.
What will remain constant is to be prepared for all
eventualities and be disciplined investors and not make decisions based on
sensational headlines or talking heads.
