by Connor Darrell CFA, Assistant Vice President – Head of Investments
The last full week of 2019 yielded additional positive returns for both stock and bond investors. It has been a stellar year for investment returns, with the S&P 500 poised to end the year up over 30% and the Barclays Aggregate Bond index set to close things out with almost a 9% gain. For U.S. equities, this would only be the 15^th time since 1937 that market returns exceeded 30% in a single calendar year. Important to consider however, is that the market’s strong returns this year were generated as a result of what analysts refer to as “multiple expansion” and not earnings growth. Multiple expansion occurs when stock prices rise faster than corporate earnings, meaning that stocks become more expensive on a relative basis. Interestingly, the opposite occurred in 2018, when stocks generated negative returns despite earnings growth well over 20%. Over the long run, it is earnings growth that tends to be the primary driver of returns, and while both 2018 and 2019 produced the opposite result in isolation, when taken together, earnings growth actually does have strong explanatory power over the past 24 months.

Following the significant multiple expansion that took place this year, the current price to earnings multiple for S&P 500 stocks is about 18.1, quite a bit above the historical average of 15.2. Moving forward, if U.S. equities are going to continue to climb higher, earnings growth will need to once again assume the role of primary catalyst. According to Refintiv, analysts are calling for mid to high single-digit earnings growth in 2020, which would be a marked improvement over 2019 earnings growth. Whether this is enough to support higher than average multiples remains to be seen. Investors can take solace in the fact that the underlying economy continues to show evidence of firming up and that the U.S. consumer remains on solid footing, both of which should help to support corporate earnings throughout the next year.