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”.

(Click on image to enlarge)

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%.

(Click on image to enlarge)

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%.

Performance recap

(Click on image to enlarge)

The US small cap index (green) soared during the last 2 months of the year, finishing the year +20%, while US large cap stocks (red) finished +18.40%, and international stocks (blue) finished +10.80%.

(Click on image to enlarge)

Clearly, the growth trade continued to work in 2020. US growth stocks were up +32.05% in 2020, while value stocks finished +1.56%. 2020 was all about software, cloud, and e-commerce.

(Click on image to enlarge)

From a sector perspective, it was technology and consumer discretionary that outperformed, while energy, real estate (commercial), and financials lagged behind.

(Click on image to enlarge)

The S&P 500 stock market index finished the year closing at an all-time high (tell me who predicted that back in March!?).

(Click on image to enlarge)

The 10-year treasury bond rate began the year around 1.875% and fell as low as 0.398%, ultimately closing at 0.917%.

(Click on image to enlarge)

The US Dollar also declined in 2020. After initial panic buying (rush to safety) during March, ultimately the unprecedented monetary and fiscal policy response (money supply increased +25%) drove the dollar lower – which should be a boost to multi-national company earnings. As of the last trading day of 2020, the dollar hit my first downside target. It found support initially, we’ll have to see if there is any follow-through.

Summary: Another year of gains for stocks that was completely driven by multiple expansion (increase in valuation). We can’t count on this to continue. The current PE is 23.6, which is 50% higher than the 10 year average of 15.9. Low rates can support higher valuations, but earnings growth will need to take the baton. In the Q3 GDP report, a record high for corporate profits bodes well for future earnings growth potential.