After Ebullient 2019, Wall Street Warns Of Slower Road Ahead

Markets are coming off a fabulous 2019, where stocks and bonds around the world climbed in concert. But for the next year — and decade, in fact — Wall Street is telling investors to set their expectations considerably lower.

It’s not calling for another crash like the U.S. stock market suffered just over a decade ago. Or for another run like the last 10 years, where the S&P 500 returned more than 13% on an annualized basis. A gain less than half of that may be more likely, both for next year and annually for the coming decade.

“People need to have a more realistic expectation of what returns are going to be,” said Greg Davis, chief investment officer at Vanguard. “That means investors who are saving for retirement or for college education will likely need to set aside more, because returns won’t be as generous as what we’ve seen over the last decade.”

It’s not because Wall Street sees the U.S. economy falling into a recession, at least not in 2020, even though that’s been a recurring fear for much of the last decade. Much of Wall Street expects the economy to chug modestly higher next year.

Instead, it’s a simple matter of math. Stocks and bonds don’t have as much room to rise after their stellar 2019, analysts say. Starting points matter, and investments began this year at a low point after recession worries pounded markets in December 2018. U.S. stocks will start 2020, meanwhile, close to their highest levels ever.

Plus, one of the biggest reasons for this past year’s stellar returns — a major about-face by the Federal Reserve to cut interest rates — can’t happen again.

Coming into this year, the mood in markets was one of fear.

The S&P 500 had tumbled 19.8% between Sept. 20, 2018 and Dec. 24, 2018. Investors were worried that the Federal Reserve was raising interest rates too far and too fast and could cause a recession. President Donald Trump’s trade war with China was also threatening economic growth.

But markets relaxed shortly after the calendar flipped, when Fed Chairman Jerome Powell pledged on Jan. 4 to be “patient.” Investors took that to mean the Fed would stop raising interest rates. Later in the summer, the Fed would go even further and cut rates three times to shield the economy from the effects of trade tensions and slowing economies abroad.

They were the first rate cuts in more than a decade, and the sharp reversal in Fed policy helped relieve investors’ anxiety about a potential recession. Lower rates make borrowing cheaper and help industries like housing and autos in particular, where customers typically have to borrow to buy.

Lower rates also mean bonds pay less in interest, which in turn makes the dividends paid by stocks more attractive to income-seeking investors. Low rates helped stock prices rise in 2019 even as profits fell for many big U.S. companies.

Along with the Fed, give credit for the resilient economy to U.S. households, which kept spending even when uncertainty about trade pushed CEOs to hold off on their own investments.

“The greatest asset in the economy is the consumer, and the U.S. consumer continues to be on strong footing,” said Mike Dowdall, investment strategist at BMO Global Asset Management.

Heading into 2020, the mood is much more giddy, but Wall Street is trying to rein in expectations.

Vanguard forecasts U.S. stocks will return 3.5% to 5.5% annually over the coming decade. Even toward the top end of that range, it’s only half what the market has returned historically. Foreign stocks might offer a bit more, at roughly 7.5% annually, but U.S. bonds look set to offer only 2% or 3% annually over the next decade, according to Vanguard.

Of course, any prediction about where investments will end up is only a guess, no matter how educated. Many on Wall Street came into this year expecting only modest returns given all the worries about interest rates and a possible recession. Now, the S&P 500 is about to close out its second-best year of the last two decades.

But for bonds, the reasons for lower expected returns are easy to see. Bonds pay much less in interest than one or 10 years ago. The 10-year Treasury now has a yield of 1.93 %, versus 2.82% a year ago and 3.54 % a decade ago. For bonds to return more than their yields, rates will need to drop even lower.

Some banks along Wall Street have relatively healthy expectations for stocks in 2020 — but few if any are calling for a repeat of 2019’s surge for the S&P 500, which was at 27.6% as of Thursday morning. Bank of America Merrill Lynch sees the index ending 2020 at 3,300, which would be a 3.2 % rise, for example. Goldman Sachs is more bullish, with a target of 3,400, but that would still be less than a quarter of this year’s gain.

Stocks are more expensive than a year ago on a host of different measures. One of the most commonly used is how a stock’s price compares to its profit over the preceding year. By that measure, the S&P 500 is trading at 20.9 times its earnings. That’s more expensive than at the start of the year, when it was at 16.5, or its average over the last two decades of 17.7, according to FactSet.

Low interest rates should help keep this price-earnings valuation high, analysts say. So will a U.S.-China trade conflict that’s hopefully no longer ramping higher, analysts say. The diminished threat of a recession should keep investors willing to pay relatively high price-earnings ratios. But the threat of policy changes in Washington, D.C., could act as a counterweight.

“There is a lot of nervousness around the elections,” said Lisa Thompson, equity portfolio manager at Capital Group. “The elections could provide some interesting opportunities for investors, particularly in the first half of the year.”

She’s the type of investor who sees volatile markets, where prices are swinging higher and lower, as “interesting opportunities” because she can use them to buy stocks she likes at lower prices.

President Trump has ushered in lower taxes and lighter regulations for businesses, which investors have seen as incontrovertible wins for investments regardless of their politics. Democrats running to unseat him, meanwhile, could reverse that momentum and target some industries in particular, such as health care. That could lead to big swings for stocks early in 2020 as Democratic candidates try to stand out in a winnowing field.

Even if the worst-case scenario were to come to pass, though, and the economy were to fall into a recession, many professional investors say they aren’t worried about a crash like 2007-09 where stock investors lost more than half their savings. Investors have remained hesitant to plow their money into stocks, even after this decade-long run, which means fund managers say they don’t see grossly overvalued markets as there were just over a decade ago.

“When the cycle does end, we don’t see bubbles out there like in 2008, 2009,” said Saira Malik, head of equities at Nuveen. “I think people are nervous.”