about 4 years ago • 3 mins
The start of a new year has understandably sent market commentators lunging for their Zoltar machines, crystal balls, and sheep livers. But because it’s tough to make predictions – especially about the future – let’s focus instead on what we can know for sure in 2020…
If you’re thinking about investing in stocks this year, you won’t have to go far to find thousands of “experts” sounding off about where to put your money. But there’s a lot of speculation and hot air out there. The key thing to remember is that a stock price is really only driven by two things: a company’s profits, and how much investors will pay for them.
When you buy a company’s shares, you’re staking a claim on (an admittedly tiny fraction of) its future earnings. That means you can expect a small amount of your original investment to come back to you in a few different ways: via direct payments (known as dividends), via buybacks (where the company purchases its own stock and pushes up the price), or via a general uptick in performance due to reinvested profits. Stock prices themselves can only get a boost either from rising profits or from greater investor demand for access to those profits, so let’s look at those two drivers separately.
Overall, earnings at large US companies are forecast to grow by 9.6% in 2020, roughly in line with the 9.1% average of the past 10 years. That paints a rosy picture for the year ahead, but bear in mind that analysts regularly tweak their estimates to reflect real-world events. If stocks start falling, you can expect analysts to cut their profit forecasts. In other words, stocks will often move first before analysts (eventually) catch up.
Now for the second driver of stock prices. Given that profits at American companies in 2019 were flat, the hefty 29% gain in US stocks was purely driven by a gain in valuations – that is, how much investors will pay to own stocks. That’s clear to see when you break down the numbers: US shares are currently trading at around 18 times their projected future profits – compared with the long-term average of roughly 15 times, and close to 13 times at the end of 2018.
Stocks may look expensive, but they still seem fairly cheap compared to bonds. That leaves room for further gains in valuations, according to some commentators: just before Christmas, an HSBC strategist wrote that, “while overall prospective returns look low, equities still appear attractively priced, compared with alternatives.”
For many Finimizers toying with the idea of investing, it probably makes sense to think in terms of decades rather than years. Investment bank Morgan Stanley has a tip for financial planning in the long term: don’t worry so much about day-to-day market performance when trying to meet your goals, but rather focus on “how much you are saving and how you are saving it.”
A report this week showed the biggest fear of American CEOs in 2020 is – yawn – a recession. Just like last year, then. But, it certainly shouldn’t come as a surprise when the current US economic expansion finally starts to sputter: all good things must, after all, come to an end. So could those CEOs – and investors in their businesses – be caught out by a genuine “Black Swan” event in 2020, like the US ramping up tensions with Iran?
Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.