After a banner year for the U.S. stock markets, many investors wonder how much further equities can rise in the year ahead.
The answer, according to Binky Chadha, chief U.S. equity and global strategist for Deutsche Bank Securities, is: absolutely nowhere.
He expects the S&P 500 stock index SPX, -0.26% to end 2020 at 3,250 which is exactly where he sees the index ending this year also. On Wednesday, the S&P 500 index closed at 3,112.76.
“Valuations are high, higher than they’ve been 90% of the time over the past five years,” he told MarketWatch, pointing out that the S&P 500 is trading at 19.1 times trailing earnings.
Outside of periods immediately following recessions, “there were only four times in the past 85 years when the multiple was higher,” he said, “in the 1960s, in the runup to the 1987 crash, during the dot-com bubble of the 1990s, and in the second half of 2018.”
While he does not expect the sort of severe corrections that occurred after these run ups in years past, the comparisons illustrate the difficult road ahead for equities next year, he said.
And while low interest rates from the Federal Reserve helps to justify higher stock prices, there are other factors that will cause equity valuations to fall.
One headwind will be what he expects to be a declining payout ratio, or the share of earnings that U.S. corporations return to shareholders in the form of share buybacks and dividends. He said that companies are returning about 90% of their earnings to shareholders today, but expects that number to fall down to 80% next year as the corporate sector reacts to slowing U.S. economic growth.
Uncertainty about President Trump’s international trade policy has already taken a toll on the economy and will do so in the months to come, Chadha said. “The economic slowdown is clear, unambiguous and broad based,” Chadha said, pointing to declining growth figures, a downtrend in survey data for both the manufacturing and services sectors, as well as slowing job growth.
While it is difficult to definitively prove that rising import tariffs and uncertainty over international trade policy is the cause of the slowdown, “I would argue that trade has been a key driver of the slowdown and that it’s hard to see the uncertainty going away,” he said.
“It looks pretty much like President Trump wants to have trade friction as part of his election platform,” Chadha added, arguing that it’s not obvious that it’s in the Trump’s electoral interest to reach a trade deal, especially if Federal Reserve policy can continue to prevent a significant selloff in the stock market.
This dynamic in which Fed policy provides ballast for the stock market, but doesn’t actually counter the impact of trade on economic growth, means that the risks are tilted to the downside in the year to come.
“I am in the deeply skeptical camp of whether monetary policy at this stage is having any real impact on the economy,” he said. “If I were on a corporate board, thinking about investment projects, I would want a firm commitment device that assures me tariffs are being rolled back and not coming back. In terms of corporate planning, the Fed is a sideshow.”