2020 Stock Market Review: Another Year Of Multiple Expansion

The S&P 500 increased by 18.4% in 2020 and closed at an all-time high. Since 1928 the S&P 500 has now averaged a 9.71% annual return. Consider all the calamities that occurred during those 92 years (we can add a global pandemic to the list now), yet $10,000 invested in 1928 would be worth over $50 million today. I wish I could tell you this will be the last bear market we’ll ever have to endure, but this isn’t realistic. There have been 13 bear markets since 1929, roughly a bear market every 7 years, and a correction (decline of 10-15%) approximately every 18 months. Like Peter Lynch famously said, “the key to making money in stocks is not to get scared out of them”.

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The formula for stock market returns is: dividend yield + earnings growth + or – change in valuation (PE)

The forward EPS began the year at $171.15 and finished at $159.02. While Q4 earnings haven’t officially been released yet, the blending earnings growth rate (combines the first 3 quarters of reported earnings plus the Q4 projected earnings) is negative -7.09% for 2020.

Earnings growth for 2019 was less than 1%.

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The majority of the gains were due to the increase in valuation (PE). Interest rates fell to record lows in 2020, getting as low as 0.40% on the 10-year. This made earnings more attractive, thus causing an increase in valuation because investors were willing to pay higher prices when rates are low.

The forward PE began the year at 18.9x and now stands at 23.6x. A 24.87% increase in valuation.

2019 was similar. Earnings growth proved to be less than 1%, while the change in valuation increased from 14.7x earnings to 18.9x (+28.6%). We had higher hopes for 2020 earnings growth to begin the year, but it didn’t turn out that way.

This is not uncommon for economic recoveries. Oftentimes the valuation increases in anticipation of stronger earnings growth in the future. Then the earnings growth materializes and valuation normalizes. Current earnings growth projections for 2021 is +23.29%, and 2022 is +16.68%.

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