If we were going to grade the U.S. economy so far this year, it would rate a solid “B,” while the rest of the world gets a “C minus.” Importantly, this disparity may be the key to understanding markets for the rest of 2019. With the U.S. in generally good shape, how long will the rest of the world continue to lag? Or, alternatively, will the U.S. begin importing weakness from overseas? These are some of the key variables as we look toward 2020.
This year we expect the U.S. economy to grow 2% to 2.25%, which is still healthy growth, but a bit slower than last year. Second quarter earnings, which will be reported over the next few weeks, could be a bit messy – mostly as a result of weakness in foreign economies. For all of 2019, we think earnings will come in at about $161 per S&P 500 share. Our estimate is about 3% below the consensus of $166 per share, as foreign economic weakness translates into weaker sales for many multinational firms within the S&P 500.
As for U.S. stock prices, we believe the market is currently overvalued by about 6% to 7%. We estimate fair value for the S&P 500 at around 2750. The trajectory for stocks for the rest of 2019 will obviously depend on how earnings come through in the second and third quarters. As mentioned above, if we get some disappointments in coming weeks, we could see U.S. stocks pull back.
In the meantime, U.S. shares have been given a reprieve in recent weeks after a trade “truce” between the U.S. and China emerged from the G20 summit. The truce allows the two sides to restart negotiations in hopes of a final deal later this year. The inherent volatility of the Trump regime creates risks, however. The President appears ready to put 25% tariffs on an additional $300 billion of Chinese imports at any time.
Potential Fed rate cuts are another important variable in the mix. Investors are expecting the Fed to cut short-term interest rates in late July. The odds on a cut are better than 50-50, in our opinion, but Fed leadership continues to be “data-dependent.” A sudden revival in domestic growth could postpone cuts. Inflation remains low and near the Fed’s target. The economy is doing well and the labor market is strong. The only reason for a rate cut might be to placate the President! Bottom line, we believe the U.S. economy is healthy enough that it doesn’t need an interest rate cut to do OK in the second half of the year.