Can returns keep rising?

The past year was a sweet one for investors: the S&P 500 was up almost 29%, while the S&P/TSX Composite returned 19%. However, investors might want to prepare themselves — and their portfolios — for a more bitter experience this year.

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“It’ll be difficult to continue the same performance in 2020,” said Luc de la Durantaye, chief investment strategist and chief investment officer, multi-asset and currency management, at CIBC Asset Management. “The U.S. equity market has been supported by a number of difficult-to-repeat features.”

One of those is Federal Reserve easing.

Instrumental to last year’s market performance was the Federal Reserve’s pivot on monetary policy. The central bank cut rates three times as it faced the economic challenge of trade tensions.

“That was the broad-based support for financial markets” last year, de la Durantaye said. “Yields declined at the long end, and equity markets rallied.”

The market likely won’t benefit from that kind of Fed action again this year.

Nor can valuations continue to rise. Particularly in the U.S. and Europe, 80% to 90% of market growth last year was attributable to multiple expansion, as opposed to growth in sales or earnings, de la Durantaye said.

As it stands, the forward price-earnings ratio of the S&P 500 is pushing 19x — a standard deviation above the average since 1990, said BMO Economics’ latest weekly equity report.

Against that background, investors face a balancing act: equity returns will likely be more modest this year, yet continued economic expansion is also on tap, de la Durantaye said.

“We see a continued gradual recovery, supported by earnings growth,” he said. Analysts expect a 10% year-over-year increase in earnings in the second half of 2020, the BMO report said.

Based on expected earnings, “equity markets should continue to perform OK — but certainly not to the same degree” as last year, de la Durantaye said.

He also forecasted that other markets could steal the spotlight from the S&P 500. “We think 2020 might be the year where the equity in the U.S. will lag other markets,” he said.

For example, in addition to its elevated valuations, the U.S. market has benefited from more share buybacks compared to other markets, he said.

Further, the U.S. market’s persistently high profit margins could reverse. “We’re facing a very tight labour market and increasing wages, and that’s going to put downward pressure on profit margins,” he said.

With U.S. stocks facing such challenges, better performance in 2020 could come from Canadian, European and emerging markets, he said.

He also noted that a number of emerging market countries — such as China, India and Mexico — have lowered their interest rates, which will be supportive for their economies.

An overall market challenge, however, will be tensions in the Middle East. With the U.S. becoming a net exporter of oil as of last fall and thus having less interest in the region, other countries are vying to exert influence.

“The consequences of that will be more volatility in the market,” de la Durantaye said.

As a result, the loonie could benefit.

“More uncertainty and volatility in the Middle East with higher oil prices could temporarily support the Canadian dollar,” he said.

This article is part of the AdvisorToGo program, powered by CIBC. It was written without input from the sponsor.