Financial markets 2020: When will P/E ratios be great again?

• Author: Brewer, Ryan M.

On November 4, the stock market hit a record level. The returns were 12.4 percent from November 4, 2018, to November 4, 2019. This is an above average return (the average is about 7 percent). Our forecast last year was that the market would increase "below average," so we were wrong.

But from November 4, 2018, to October 9, 2019 (233 days), the returns were 6.6 percent, so we were really on track most of the year. But then the market proved us wrong by adding $1.5 trillion to the wealth of Americans in 18 days. Given the whipsaw of economic news reports, if we just wait for the right moment to measure annual returns, we can make financial market forecasts great again.

We think what happened over those 18 days is indicative of what will happen in 2020. Lets review:

* The Federal Reserve cut the federal funds rate. This shifted many interest rates down (not the mortgage rate though). Cutting the federal funds rate is often, but not always, a path to lower interest rates. It was this time. Lower interest rates are a common way that stock prices rise. It seems the market responded to the cut, at least to this point.

* The interest rate story about our economic future reversed. From the end of May until October 15, longer-term rates were lower than the short-term rates. This is called an "inverted yield curve." It is a common sign that the market expects a recession since lower interest rates often indicate lower economic activity. But then, magically, the longer rates went higher than the shorter and remain there. It seems stocks responded to the forecast by moving up (or maybe the reverse happened?).

* The perpetual trade war seems to be petering out. The trade deficit with China fell 3 percent in September, and for the moment the two sides appear to be closing in on a deal. The U.S. trade deficit fell in September.

Still, economic growth is anemic and the U.S. trade deficit is 13 percent higher than when Trump took office. The great economic question of the Trump administration is how much faster the economy would be growing without the damage of his trade protectionism. The recent report of lackluster 1.9 percent growth in the third quarter shows again that you can't escape Adam Smith's revenge for indulging in bad economic policy stemming from political goals.

The economy continued to grow as consumer spending provided nearly all of the growth in GDP. For the second quarter in a row, the mighty consumer had to offset falling business investment to produce positive growth.

The last two quarters of business investment have been negative after nearly two years of healthy gains that had revived with the Trump presidency and the recharging of business animal spirits. Early on in the administration, the Trump policy mix of tax reform and deregulation clearly made a difference to investment and growth. Investment accelerated in 2017 after falling in the Obama administration. Estimates are that U.S. companies repatriated nearly $1 trillion from overseas since tax reform passed.

GDP growth accelerated to 3 percent for a time in 2017-2018 along with investment, but then came Trump s entirely discretionary trade intervention. More than the damage from...