After watching the market yo-yo higher and lower in the first 6 months of 2018, it finally gained some traction on the heels of a stronger economy and fantastic earnings announcements. It seemed like every day during earnings season we got news of another company beating the analyst estimate and raising their outlook. Additionally, strong employment numbers, a solid GDP rate of 4.2% and relatively tame inflation readings added to the market’s confidence. There is no question that the tax cuts have given companies new confidence and a better earnings environment.
The performance results were stellar. The S&P 500 posted a gain of 7.2% while the Dow and NASDAQ were up 9.0% and 7.1%, respectively. It was the best quarter for the S&P 500 since 2013. We now enter the fourth quarter of 2018 and it’s time to start focusing on the expectations for 2019. As we normally do, we like to keep an eye on the valuations of the market — especially as this bull market continues to mature. The good news is that the expectations are for earnings growth of over 14% from 2018 to 2019. This is an extremely strong growth rate. The bad news is that the S&P 500 now trades at 17.8x 2019 estimated earnings. So we are bumping up against the higher end of average.
This type of above average valuation is sustainable so long as the growth rates remain elevated. With the Federal Reserve raising rates to fend of inflation, this type of growth may not be able to be sustained. It also means that if the market is to go higher, then the earnings will need to continue to surprise to the upside to keep up with the valuation. As we move forward, we believe the market may be a bit more volatile than usual as it reacts to the day-to-day headlines. We will see headlines on tariffs, trade deals and rate hikes, as well as inflation reports, GDP reports, employment reports and of course the mid-term elections. These headlines will certainly drive the market’s direction day to day, but hopefully a good earnings season will help that ever important earnings growth which is the ultimate driver of the market’s long-term performance.
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