It was a rare moment as President Trump began a televised address to the country Wednesday in the wake of Iran’s missile attack on two military bases in Iraq housing American troops.
Was the commander in chief about to declare war? Would he seek to de-escalate tensions? So much was at stake, but no one really knew. In financial markets, all traders, fund managers, and other investors could do was hang on every word.
Once it became clear that Trump would authorize sanctions, not airstrikes, on the Iranian government, stocks rallied and oil prices fell. You could almost hear Wall Street’s collective sigh of relief.
The confrontation with Tehran is not over, but if the past year is any guide, US investors will move on. They have remained remarkably resilient in the face of consternation caused by the US-China trade fight, Britain’s messy divorce from Europe, and slowing growth across the globe.
But the next hurdle is decidedly more fundamental: corporate earnings. With stocks carrying premium prices based on rosy profit forecasts for 2020, results that fall significantly below expectations could slow, if not reverse, the market’s march higher.
“The question for 2020 is whether earnings come through to justify the anticipation in 2019,” said Jurrien Timmer, director of global macro at Fidelity Investments in Boston.
The bull market — the Standard & Poor’s 500 set repeated records as it gained nearly 29 percent in 2019, the biggest jump in six years — underscores the US economy’s ability to chug forward against headwinds overseas.
The economy expanded an estimated 2.3 percent in 2019, according to a December survey of business economists, even as growth in China, our third-largest trading partner, fell to its lowest rate since 1990. The United States, paced by consumer spending, easily outperformed our other big trading partners — Mexico, Canada, Japan, and Germany — data from the Organisation for Economic Co-operation and Development show.
Forecasters expect growth of the US economy to slow to 1.8 percent this year, a respectable rate given constraints such as a tight job market, which has made it tough for employers to find workers. The Federal Reserve — whose pivot last year from raising interest rates to lowering them boosted stocks — has signaled that it will keep credit loose.
The sanguine attitude among investors also reflects how the domestic economy is far more insulated from turmoil in the oil-producing Mideast than it was in 1990-1991, when a spike in crude prices after Iraq’s invasion of Kuwait led to a brief recession. Similarly, the United States suffered recessions set off by the oil crises of 1973 (OPEC embargo) and 1979 (Iran’s Islamic revolution).
The reason, of course, is that the United States has gone from relying heavily on imported oil to having so much of its own that it will be a net exporter of energy in 2020, according to a forecast by the US Energy Information Administration. The country is already the world’s largest producer of oil and natural gas, thanks to the adoption of a controversial process known as hydraulic fracturing, or fracking, the agency’s data show.
In the past, oil prices probably would have remained elevated after incidents such as the US drone attack earlier this month that killed Iranian General Qassem Soleimani or Iran’s drone strike against two Saudi Arabian oil fields in September. In both cases, the spike was temporary.
So was the drop in the stock prices. The S&P 500 is up 1.1 percent this year, quickly recovering after both the Soleimani assassination and Iran’s retaliation.
“The oil market isn’t viewing this as an event at this point,” said Bill Zox, chief investment officer for fixed income at Diamond Hill Capital Management in Columbus, Ohio. “Our economy is just much less oil-dependent than it has been historically.”
The comparison isn’t perfect, but after Iraqi troops poured into Kuwait on Aug. 2, 1990, the S&P 500 fell 17 percent through mid-October of that year, Zox noted.
Hans Olsen, chief investment officer at Fiduciary Trust in Boston, said that geopoltitical shocks to the market tend to be short-lived unless they deliver a heavy hit to corporate earnings and increase the level of risk in holding stocks, compared with ultra-safe government bonds.
“In the short term, markets are incredibly messy. But you find that they figure it out pretty quickly,” he said.
Olsen said the more probable source of a shock would be a financial fiasco that shakes confidence in the markets, such as the demise of the investment bank Lehman Brothers in 2008.
“What has the potential to rock the market . . . is the failure of a financial institution, a systemically important financial institution,” he said.
Stocks in the S&P 500 index are trading at prices that average about 18 times analysts’ estimates for per-share earnings over the next 12 months, according to data from FactSet. That ratio means stock are fairly expensive; the average for the past 10 years has been 15 percent. Analysts say the current valuations reflect forecasts that earnings will climb this year after falling in 2019.
Fourth-quarter earnings season ramps up this week, with companies in the aggregate forecast to report a 1.5 percent decline in profits by the time it winds down in March.
The market has already priced in weak earnings and will instead be focused on guidance given by company executives for the new year, said Dan Kern, chief investment officer at TFC Financial in Boston. Analysts forecast that earnings in 2020 for S&P 500 companies will increase 9 percent, compared with an estimated drop of 0.3 percent when all the numbers for 2019 are in, FactSet reports.
“Earnings expectations are probably higher than they should be,” said Kern, adding that a increase in profits for the year “in the low- to mid-single digits” is more realistic.
“And that’s a recipe for a market that grinds upward rather than another year of double-digit gains,” he said.
The bottom line: Even as the headlines are dominated by turmoil overseas, Washington infighting, and the 2020 elections, pay attention to the bottom line.
Correction: An earlier version of this story didn’t give Bill Zox’s full title at Diamond Hill Capital Management. He is chief investment officer-fixed income.