LPL Midyear Outlook: Equities Focus

We continue to believe in our year-end fair value estimate for the S&P 500 Index in the range of 3,000, as we discussed in our just-released Midyear Outlook 2019: FUNDAMENTAL: How to Focus on What Really Matters in the Markets, and we would view any decline beyond 10% as excessive, given current fundamentals on economic growth, corporate profits, inflation, and interest rates.

We expect corporate profits will help drive second-half gains for stocks (another earnings season is right around the corner, by the way). As LPL Chief Investment Strategist John Lynch noted, “Due to the increased risk of a prolonged trade war, we slightly reduced our S&P 500 earnings per share (EPS) forecast for 2019 to $170, which would represent 5–6% EPS growth, if realized. Importantly, that forecast is still above Wall Street’s consensus of $168, which we suspect is too low considering the mostly positive fundamental environment.”

Even though tariffs have curbed the earnings outlook a bit, U.S. stocks remain reasonably valued. The S&P 500’s forward 12-month price-to-earnings (P/E) ratio of 16.6 (Source: FactSet) is within historical norms, and P/E ratios relative to interest rates and inflation are both well below long-term averages.

Historical patterns also point to more gains. Stocks’ strong start to a year usually has boded well for the rest of the year, as the S&P 500  has historically risen an additional 6% over the rest of the year after a first-quarter gain of 10% or more.

Of course, stocks don’t go up in a straight line. Historically, when the S&P 500 has gained 10% or more in the first quarter, as it did this year, stocks have endured an average pullback of about 9% at some point in the year before recovering later in the year. Risks that could potential drive volatility include the geopolitical environment, the possibility of failed trade negotiations, or a potential monetary policy mistake.

So how do we think investors should position equity portfolios in this environment? As shown in our LPL Chart of the Day, “Our Views on Equities,” regionally, we prefer emerging markets and the United States, while we slightly favor value stocks over growth. We have a slight bias toward large cap stocks over small based on valuations, an aging business cycle, and our expectations for improvement in the global trade environment. However, we recommend near-benchmark level exposure to each, which implies a much larger allocation to large caps. Despite the length of this expansion, our sector positioning remains cyclical, with overweights in industrials, financials, and technology.

For more on our outlook for U.S. equities for the rest of this year, please read our Midyear Outlook 2019. We will also feature Midyear Outlook content in the upcoming Weekly Market Commentary on July 1.

IMPORTANT DISCLOSURES

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual security. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. The economic forecasts set forth in this material may not develop as predicted.

All indexes are unmanaged and cannot be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment. All performance referenced is historical and is no guarantee of future results.

Investing involves risks including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments.

International investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors. These risks are often heightened for investments in emerging markets.

Investing in foreign and emerging markets involves special additional risks. These risks include, but are not limited to, currency risk, geopolitical risk, and risk associated with varying accounting standards. Investing in emerging markets may accentuate these risks.

Earnings per share (EPS) is the portion of a company’s profit allocated to each outstanding share of common stock. EPS serves as an indicator of a company’s profitability. EPS is generally considered to be the single most important variable in determining a share’s price. It is also a major component used to calculate the price-to-earnings valuation ratio.

The price-to-earnings (P/E) ratio is a measure of the price paid for a share relative to the annual net income or profit earned by the firm per share. It is a financial ratio used for valuation: a higher P/E ratio means that investors are paying more for each unit of net income, so the stock is more expensive compared to one with lower P/E ratio. Price to Forward Earnings is a measure of the P/E ratio using forecasted earnings for the P/E calculation.

This Research material was prepared by LPL Financial, LLC.

Please see the Midyear Outlook 2019: FUNDAMENTAL: How to Focus on What Really Matters in the Markets for additional description and disclosure.

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