What’s the Outlook for the US Stock Market in 2020?

Episode Summary

Executive Summary: Goldman Sachs’ 2020 U.S. equities outlook is cautiously positive: Tony Pasquarello highlights rich valuations but supportive low rates, strong equity risk premium, and potential mean reversion in flows; David Kostin forecasts the S&P 500 at 3,400 by end-2020, driven mainly by ~5% EPS growth from 2.3% GDP growth, flat margins, and buybacks, assuming divided government, stable Fed policy, and only modest trade improvement.

Main Topics: 2019 market backdrop and valuation reset (Priority: 5/5): The episode opens by framing 2019 as a standout year for risk assets, with the S&P 500 up strongly after a weak 2018 base. The move was driven largely by valuation expansion rather than earnings growth, helped by the Fed pivot to easier policy. Stocks vs. bonds and the equity risk premium (Priority: 5/5): Tony argues that while equity valuations look elevated versus history, they remain attractive relative to very low bond yields. The equity risk premium and negative real policy rates support the case for equities over fixed income. 2020 S&P 500 forecast and earnings math (Priority: 5/5): David Kostin lays out the core forecast: S&P 500 at 3,400 by year-end 2020, implying about 6% upside. He ties this to nominal GDP growth, stable margins, and share repurchases, which together point to roughly 5% EPS growth. Election scenarios and policy risk (Priority: 5/5): A central theme is the U.S. election. The baseline assumes divided government persists, keeping taxes and policy stable. A unified Democratic government and tax rollback could materially lower earnings and push the market toward 2,600. Fed policy, rates, and macro backdrop (Priority: 4/5): The Fed is expected to remain on hold well into 2021, keeping short rates low and supporting equity valuation. The consumer remains a strong engine of growth, while CEO confidence is weak due to political and trade uncertainty. Trade, tariffs, and sector dispersion (Priority: 4/5): The team expects only modest tariff rollback and no broad trade settlement. Market participants are already pricing some resolution, and sector impacts—especially in healthcare and technology—may matter more than broad market direction. Buybacks and capital flows as a risk factor (Priority: 4/5): A notable concern is the reversal in corporate share repurchases after tax reform. Tony and David both highlight flow shifts out of equities and into bonds/money markets, with buybacks still large but expected to decline modestly in 2020.

Key Arguments: 2019’s strong equity performance was heavily aided by the 2018 selloff and the Fed’s shift from expected hikes to cuts, leading mainly to valuation expansion rather than earnings growth. Even at elevated absolute valuations, equities remain relatively attractive because bond yields are extremely low, leaving the equity risk premium above historical norms. The 2020 market forecast is fundamentally an earnings story: ~2.3% real GDP growth, ~4% nominal GDP growth, flat margins, and about 100 bps from buybacks translate into roughly 5% EPS growth. Divided government is the baseline assumption and supports the 3,400 S&P target because it implies policy stability and no major corporate tax rollback. A unified Democratic government could reverse some of the 2017 tax cut, shrinking 2021 earnings growth from +5% to about -7% and potentially pulling the S&P 500 toward 2,600. The Fed is expected to keep rates low and stable, which is bullish for risk assets because equities are valued more favorably relative to interest rates. The consumer is the key macro support for the economy: low unemployment, rising wages, low inflation, and strong household balance sheets should sustain expansion. Trade remains a risk but is not the base-case driver; the market is assumed to get only modest tariff relief and no comprehensive trade breakthrough. Corporate buybacks are a major source of equity demand, but the recent slowdown/reversal in repurchases is a meaningful uncertainty for 2020. Sector-level politics, not just broad-market politics, will drive investor debate, especially around healthcare, technology, and privacy regulation.

Data Points: S&P 500 total return in 2019: 31% - Tony’s headline market number; best year since 2013 and a 93rd percentile outcome historically. S&P 500 forward P/E start/end 2019: 14.4 to 18.8 - Valuation multiple expanded sharply over the year. P/E historical percentile: 90th percentile - 18.8x forward earnings is high relative to the past 43 years. Equity risk premium: ~500 bps - S&P 500 earnings yield minus 10-year Treasury yield, versus a historical ~370 bps. 2-year Treasury yield: 1.56% - Short-rate anchor that signals easy Fed policy and supports risk assets. Money market inflows in 2019: $572 billion - Record inflow into cash-like assets. Fixed income fund inflows in 2019: $644 billion - Record inflow into bond funds. Equity fund outflows in 2019: $229 billion - Near-record outflow from equities, second only to 2008. Total flow wedge: $1.445 trillion - Difference between inflows to fixed income/money market funds and outflows from equity funds. Patriots winning percentage in the 2010s: 0.781 - Tony’s personal number outside the office; best among major U.S. sports franchises. S&P 500 year-end 2020 target: 3,400 - David Kostin’s baseline forecast. Implied upside from current level: ~6% - Assumes the index starts around 3,200. Expected U.S. GDP growth in 2020: 2.3% - Baseline macro assumption from Goldman Sachs economics team. Expected average S&P 500 profit margin in 2020: 10.8% - Slightly above current level. Expected S&P 500 EPS growth: ~5% - Derived from nominal GDP growth, flat margins, and buybacks. Nominal GDP growth assumption: ~4% - Real GDP a little over 2% plus inflation a little under 2%. Share repurchase contribution to EPS growth: ~1 percentage point - Buybacks add to earnings-per-share growth. Potential bear market expectation: No 20% decline expected - David does not expect a bear market in 2020. Alternative S&P 500 downside scenario: ~2,600 - If tax cuts are rolled back under unified Democratic government and uncertainty rises. Corporate tax rate before/after 2017 tax cut: 27% to 19% - Rollback of this tax cut is the key downside policy scenario. Forecast long Treasury yield end-2020: 2.25% - Slight rise from current levels in the base case. Expected Fed policy horizon: On hold until latter part of 2021 - Stable monetary policy assumption. U.S. federal deficit in 2020: About $1 trillion - Limits scope for new fiscal stimulus. U.S. consumer share of GDP: About 70% - Consumer spending is the key macro growth engine. Wage growth: Around 3.5% - Supports consumer spending in a low-inflation environment. Inflation: Less than 2% - Keeps real wages rising. Current buyback forecast for 2020: ~5% decline - David expects a modest pullback in corporate repurchases. Forecast buyback spending level: A little under $700 billion - Still a significant source of equity demand. U.S. corporate revenue share generated domestically: 70% - Used to argue that trade matters, but less than domestic economy conditions. Likelihood priced in by equities for trade resolution: Above 70% - Based on relative stock performance of companies with China exposure.

Pivotal Quotes: "I expect the market will rise. Rise modestly at the beginning of the year to around 3,250 and then bounce around for a good part of the year until the election." — David Kostin: Summarizing the expected path of the S&P 500 during 2020. "The baseline assumption that we are using is that the divided government that we currently have... persists in some form in 2020 after the election." — David Kostin: Explaining the core political assumption behind the 3,400 target. "The one metric that equities are actually quite attractive is valued relative to interest rates, which have remained low for quite some time." — David Kostin: Justifying why high absolute valuations do not automatically imply poor forward returns.

Implications: For investors, the base case favors staying invested in equities, especially if rates stay low and earnings grow as expected. The biggest swing factors are the election, tax policy, trade, and buybacks, with sector selection likely more important than broad market timing.