The stock market currently trades at record highs. The index posted its biggest annual gain since 2013. Furthermore, the S&P 500 companies issued $485bn in dividend payments last year, which is the eighth consecutive year of record payments. Judging by the 2019 performance, everything looks rosy.
Before you get carried away and invest all your savings in stocks, we would like to grab your attention for a moment. The chart below, from Ned Davis Research, shows the sales of S&P 500 companies relative to the price of the index.
As seen on the graph, two times in the past the price of the index was substantially higher than the 12 month sales ratio. During both occasions – around in the early 2000s and before 2008 – the index price corrected sharply lower to catch up with the sales line.
The current gap between the two lines is the biggest one historically i.e. the S&P 500 is now more overvalued than ever. According to this measure, a stock market pullback is due. Therefore, if we can trust this cart, the stock market is likely to correct nearly 40% lower to catch up with the sales.
Different measures, such as conventional price-to-earnings (P/E) ratio, show the stock market is overvalued as well. One of these statistical projections, based on the median price to earnings ratio, signals there is room for a 30% correction.
Bank analysts: Correction is coming
Bank and financial analysts read this type of charts as well. Based on their information and projections, many analysts see 2020 as a correction year for the stocks. Let us now look at some of these projections for the current year.
“The extreme overbought condition and excessive optimism set up an environment that was ripe for a tactical correction, and the developing Iranian conflict may act as a catalyst for one. A correction signals a 10% decline from the 52-week high”.– Canaccord Genuity
“Continue to be choosy on growth stocks with quality earnings and cash flows that aren’t egregiously overvalued… In the near term as markets potentially correct, defensive stocks should have a good run/catch-up as US rates fall on geopolitical concerns and growth doubts”.– Morgan Stanley
“We see material scope for an upward move. A 10% stock market correction in the first half is possible; we can envision one in late March/early April when the Fed’s balance sheet possibly stops growing”.– Wells Fargo Securities
Looking ahead to 2020, we are not ruling out the possibility of some sort of market pullback or correction. In fact, as we have stated many times in our previous reports, we expect that the heightened uncertainty among investors is here to stay, and will lead to elevated levels of volatility in the upcoming year. However, we do not anticipate this price drawdown—if it does in fact occur—will be as severe as many investors and market pundits appear to be portraying.– BMO Capital Markets
Despite the geopolitical turmoil and global trade concerns, nearly all stocks hit record prices in 2019. Due to reasons outlined above, it is hard to imagine a repeat of 2019 for the stock market investors. The projections of the expected correction vary from 10% to 40%, however, one this is certain – the pullback is coming.