By: Ross Silver, Principal Analyst 

Happy 2020 and I hope you enjoyed your holiday season. 2019 was a monster year for equity investors as the major averages ended the year up 25%+. Will 2020 also bring outsized returns relative to mean returns over the past 100 years or will we revert to the mean or fall below? Let’s take a look at some factors that may contribute:

Cyclical Factors:

Presidential elections also tend to be favorable, with the market advancing in 17 of the past 19 years when White House campaigns were held, and 2020 will be one of those years.

This doesn't work perfectly, of course. The 37% slide in 2008, during the Great Recession, was one of the worst ever. Still, presidential campaigns tend to generate excitement, and optimistic election speeches often drown out the rancorous political divides along the way.

One wild card might involve income-tax changes, as several leading Democrats have advanced proposals to tax corporations and the rich more heavily. Such concepts might prove popular on Main Street, but they won't fly on Wall Street. If high-tax proposals gain serious traction, that could spook investors. But at this stage, they're just ideas.

Anticipation of Profits:

The market's performance last year was unusual in that the big gains came against a dismal earnings backdrop. Pending the release of financial reports for 2019's fourth quarter, earnings for S&P 500 companies will slip 1.7% on average for the year, according to Zacks Investment Research. That follows a 23.2% profit gain, on 9.2% higher revenue, for 2018, when corporate bottom lines were juiced by income-tax cuts.

Clearly, investors are looking beyond the chasm. Zacks sees earnings for large corporations rising about 8% in 2020 on roughly a 4% increase in revenue, based on the projections of analysts who follow S&P 500 companies.

In his blog, Sheran Mian, Director of Research at Zacks, concluded that investors appear to have accepted profit declines in 2019 in hopes that profit gains will resume this year. 

Valuations:

A strong stock-market advance, coupled with weak earnings, is one way to stretch valuations. That scenario unfolded last year. For example, the market's price-earnings ratio based on forward or expected profits stood at 18.2 at the end of 2019, up from 14.4 one year earlier, according to JPMorgan Asset Management.

Similarly, the market's price-book value ratio rose to 3.3 from 2.7 and price-cash flow increased to 13 from 10.6. (These ratios compare the stock price to a company's assets and cash flow, respectively, also expressed per share. The specifics, in this case, aren't as important as the direction they're moving. Right now, that movement is toward stocks becoming modestly more expensive.)

Similarly, the average S&P 500 dividend yield, at 1.9%, was below the 2.3% year-earlier figure. Those numbers, and others, suggest stocks have gotten more costly. Still, most valuation measures aren't way out of line. For example, the average forward P/E ratio of the past 25 years is 16.3. That 1.9% dividend yield compares to similar or even lower payouts on bonds, such as the 1.9% yield on 10-year Treasury bonds.

Good luck in 2020!