Stocks in 2019: what a difference one year makes

Chart of the week

In 2018, earnings were growing at double-digit rates, while equity markets were trading down. In 2019, however, earnings stagnated, and equities rose substantially.

What a year! From today's point of view, market comments from one year ago are a fun reading. Back then, people had trouble explaining what had just happened to them: on December 24, 2018, the S&P 500 fell to 2351, its lowest level since May 2017 and, after a decline of 19.75% since September 2018, only a whisker away from a bear market. "What on earth is the market trying to tell us?" was the question of the day. The irony is that earnings in 2018 were growing at double-digit rates, while equity markets were trading down. In 2019, however, earnings stagnated, but global equities (MSCI World Index) rose 25%.

This week, we’re unearthing our beloved chart of S&P 500 valuation bands. Our "Chart of the Week" shows, that going back to 1970, the average price-to-earnings (P/E) ratio of the S&P 500 was 17.3, based on last-twelve-months (LTM) earnings. Given current earnings and prices, we calculate a P/E ratio of above 20, which is not at a record level, but qualifies for being classified as stretched.

However, as Thomas Bucher, equity strategist at DWS, keeps saying, today’s valuation doesn’t tell you anything whether the market will go up or down tomorrow. In fact, even on a 12-month horizon, valuation has only a limited explanatory power of stock returns. This correlation, however, increases with the time horizon: elevated valuations do suggests that the expected equity returns over the next, say, 10 years are likely to be below the long-term average. But that’s still way off, and we’ll probably post an updated valuation-band chart next year again.


* Each band represents the S&P 500's hypothetical price development assuming a P/E multiple of 14, 16, 19, 21 and the average since 1970 (17.3)

Sources: Refinitiv, DWS Investment GmbH as of 12/27/19



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