Why the US equity bull market could end next year

The S&P 500 may be in the midst of its longest ever bull market, but it’s likely to end next year much lower than it is now, even as companies’ sales have risen, Capital Economics said in a note last week.

“A key reason why the U.S. stock market is likely to come a cropper between now and the end of 2019 is faltering corporate profits given the outlook for sales and margins,” said John Higgins, chief markets economist at Capital Economics.

“We are sticking to our forecast that the S&P 500 will end next year at 2,300. This would be a fall of almost exactly 20 percent from its peak. If so, the bull market would then be all but over,” he said.

The index ended Friday up 0.62 percent at 2874.69.

While S&P 500 companies’ sales were probably up by a double-digit rate in the second quarter, it reflects an upturn in the U.S. and global economy over the past two years, he said.

“But we expect growth to slow sharply in the U.S. next year, as the boost from fiscal stimulus fades and monetary tightening bites. We also think that growth will ease abroad, where S&P 500 companies make more than 40 percent of their sales on average,” Higgins said. “If the trade war escalates, the foreign subsidiaries of S&P 500 companies will also find it harder to operate and compete.”

He also noted that while S&P 500 companies saw their profit margins after tax jump over the past year, in aggregate, some of that is likely to be a one-off due to the U.S. tax cuts, with the pre-tax profit margins not up as much.

Rising labor costs in the U.S. were also set to rise as the jobs market continues to tighten, while non-labor costs may rise if the trade war boosts import prices, with any trade war escalation set to raise costs at overseas subsidiaries, the note said.

Analysts may be penciling in earnings per share growth to slow to the “low double-digits” in the second half of 2019, from expectations for around 20 percent growth over the next year, this still appears “far to high,” Higgins said.

That might also weigh on the valuations that investors are prepared to pay for index earnings, even as higher interest rates may reduce the incentive to hunt for stock returns, he said.

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