The 2019 year experienced a market rally that ran through the 4th quarter and ended with the S&P 500 posting a total return of 31.49% for the year.1 Following a significant selloff through the final quarter of 2018, expectations made an about-face after the Federal Reserve Bank indicated it would reduce — instead of increase — the Fed Funds rate. As a result, the markets seemed to gain traction following this announcement, with the added benefit of the de-escalation of the trade war with China creating a positive impact during this time, as well.
Earnings estimates that were reported as better than originally anticipated led to a fundamentally justified increase in stock prices. However, as the year went on and the market continued to move higher, the price-to-earnings (P/E) ratios of S&P 500 companies expanded. Altogether, the market ended the year willing to pay quite a bit more for $1 of earnings than when it began. The chart below illustrates the increase of P/E ratios from the beginning of 2019 to year-end.2
With the recent rally in the market and the expansion of P/E multiples, the Resolute Investment Committee made the decision to implement changes to our normal target allocations. Ultimately, it was decided that a 5% reduction to equity exposure across our target allocations would be prudent, and trades were placed on January 3, 2020, to affect that decision.
While, overall, S&P 500 companies’ earnings estimates continue to show improvement, they are doing so at lower growth rates than once projected. The stock market has been increasing at a faster pace than earnings growth estimates, which leads us to believe that future gains in the stock market could be heavily dependent upon further P/E multiple expansion.
These steps are not a prediction of how markets will perform in 2020, but rather, a representation of our philosophy at work — capturing growth, where possible, for the better preservation of wealth.
We will continue to follow the data and keep you informed of any changes we are making that may affect your investment portfolio, and as always, we look forward to our next conversation.
1 Source: Morningstar — the total return of the S&P 500 index includes daily reinvestment of dividends.
2 Source: The Earnings Scout