In addition to Trade War uncertainty, US stock markets must grapple with problematic earnings estimates for 2020. Typical year-start estimates are higher than actual outcomes, as a bias toward optimism appears around the year-end holiday time. A good example is 2019 when year-start estimates for the S&P 500 were in the $174–178 range. The actual result for 2019 is more likely to be $162–164.

The 2020 US stock market outlook depends on economic growth worldwide. And continued growth depends on the outlook for a Trump Trade War ceasefire and on a lack of serious financial shocks (like a breakdown in American CLOs or credit deterioration of many countries’ junk bonds or Chinese banking system risk). In the absence of shocks, the market is pricing an approximate 19 price/earnings multiple on the S&P 500 Index.

Consider the equity risk premium with a 19 or possible 20 multiple. The earnings yield would be about 5%. There would be no margin for any shocks or any errors. Without the shocks, a higher trajectory for stock prices can continue and be sustained. Any shock calls that assumption into question. One can argue that the benefit for stock prices that is attributable to low-interest rates has run its course. In fact, we see lower rates or negative rates a threat to the stock market.

If we are correct in that assumption, the engine for higher stock prices depends on higher earnings and positive earnings surprises. Will we see them?

Our friend Christopher Whalen has penned a superb analysis of the banking sector, titled “Four Charts: US Bank Earnings Are Falling”. If Chris is correct, the banking sector must experience zero shocks if it is to sustain a flattening earnings trend. Note that Cumberland is underweight large banks; we’ve taken the profit in that position.

Other sectors have different levels of exposure. We will talk about them in future year-end and 2020 forecast commentaries.