2019 was an excellent year for the stock market with many major indices, including the S&P 500, reaching all-time highs. Whether investors can expect such strong performance to persist depends on why returns were so strong in the first place. A simple analysis suggest the gains from last year are likely NOT sustainable.

Stock returns can be broken down into three primary components:

  • Earnings Growth(1)
  • Dividend Yield(2)
  • Valuation Change

According to data published by FactSet, 45% of companies in the S&P 500 have reported earnings for the 4th quarter as of last Friday (1/31). If you compare the actual results of the companies that have reported with estimates for those companies that have yet to report, earnings growth for 2019 is expected to be -0.3%. The dividend yield for the S&P 500, meanwhile, has generally fluctuated around 2% for the past couple of years. With the first two components making a negligible contribution, the S&P 500’s 31.5% return for 2019 was largely a function of valuation change. The chart below supports this idea. The price-to-earnings (P/E) ratio, a popular valuation metric that measures the price investors pay to participate in a dollar of business profits, increased substantially during 2019(3).

Source: Morningstar Direct. Chart reflects the P/E ratio for the S&P 500 index from 1/31/01 – 12/31/19.

The implication here is that the S&P 500 did not rise in price due to a tangible improvement in the underlying businesses. Instead, it rose simply because investors were willing to pay more for them. There were a few factors that contributed to this, including:

  • The selloff during Q4 2018 depressed the P/E ratio to a level slightly below the long-term average. Part of the increase was a function of recovering from that decline.
  • Investor sentiment became elevated late last year as news broke that the U.S. and China had reached a “Phase-One” agreement in trade negotiations.
  • Last year the Federal Reserve transitioned from tightening interest rates, to being on hold, to cutting interest rates by 0.25% three times. Lower interest rates are generally considered good for the stock market and supportive of higher valuations.

The valuation change that propelled the S&P 500 last year is NOT sustainable, because it tends to mean revert in the intermediate to long-term. To conceptualize what this means, think of it as a rubber band. When stretched, tension builds as the band wants to return to its normal state. While the forces causing the band to stretch can continue further than expected, the more stretched it gets the more likely it will snap back, and the more dramatic the snap will be when it does. It’s possible that valuations continue to stretch in 2020, but it’s not prudent for investors to expect this to happen. Meanwhile, the dividend yield on the market typically does not change much from one year to the next, and will likely remain in the low single digits. For sustainable market gains moving forward, we need to see businesses grow their earnings.


1. A slightly more technical approach would be to separate real (inflation-adjusted) earnings growth from inflation.

2. Practitioners generally include the effect of net share issuance with dividends, referred to the combination as “Shareholder Yield”. When stock buybacks exceed new share issuance it is a positive for returns, while new share issuance exceeding buybacks would be a negative.

3. The P/E ratio is a valuation metric that is sometimes referred to as a “price multiple”, as it measures the price an investor must pay as a multiple of $1 of some fundamental metric. Revenues, cash-flows, or book-value are other types of valuation ratios. When these ratios increase, it is often referred to as “multiples expansion”.


  • Last Wednesday the Federal Reserve concluded its first policy meeting, and as expected left the benchmark federal funds rate in the current range of 1.50-1.75%. The Fed has failed to reach their 2% target on core Personal Consumption Expenditures (core PCE, their preferred inflation gauge) for an extended period of time. As a result they appear biased towards easy monetary policy as they continue to monitor the impact of 2019’s three rate cuts. According to data from the CME Group, the market is expecting the next move in rates to be a cut at the September meeting.
  • Four years after the U.K. voted to leave the European Union, Brexit quietly occurred on Friday (1/31). They have now entered a twelve month transition period, during which the two sides will negotiate a new trade deal that will govern their relationship moving forward.
  • The Bureau of Economic Analysis (BEA) published the first estimate of Q4 Gross Domestic Product (GDP). GDP, a popular representation of economic growth, came in at 2.1% and matched the pace from the previous quarter. Beneath the headline figure, the underlying details were not quite as strong. GDP got a large boost from net trade, caused by a sharp decline in imports. This is generally not considered a sustainable source of growth, and actually reflects weaker domestic demand. Other data published in the U.S. showed manufacturing activity unexpectedly increased in January. The Institute for Supply Management’s Manufacturing Index increased from to 50.9 from 47.8, and showed growing activity for the first time in 6 months (any read above 50 reflects expansion). This is welcome news, as manufacturing has been a real weak spot in the economy.



  • This Earnings Season Is Better Than You Think (Barron’s)
  • When Does the Federal Deficit Matter? (AWOCS)
  • Yield-Curve Inversion is Sending a Message (Bloomberg)


  • The Stock Got Crushed. Then The ETFs Had to Sell (Zweig)
  • 3 Big Themes in ETFs Right Now (


  • How much Are We Paying For Our Subscription Services? A Lot (NYT)
  • The Illusory Truth Effect: Why We Believe Fake News, Conspiracy Theories and Propaganda (FarnamStreet)


Source: MarketWatch


Source: Morningstar Direct.

Source: Morningstar Direct.





Source: FRED Database & ICE Benchmark Administration Limited (IBA)

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

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Josh Jenkins is a Senior Portfolio Manager & Head of Research at Lutz Financial with over nine years of investment experience. He is responsible for assisting clients in the construction, selection, and risk assessment of their investment portfolios. In addition, Josh will provide on-going research and trade support.

  • Asset Allocation & Portfolio Management
  • Investment & Market Research
  • Trading
  • Chartered Financial Analyst (CFA)
  • Chartered Financial Analyst Institute, Member
  • Chartered Financial Analyst Society of Nebraska, Member
  • BSBA, University of Nebraska, Lincoln, NE

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