Q4 Recap: Valuation Expansion the Driver

by | Jan 6, 2020 | Market Updates


  • S&P 500 soared by 31% in 2019, marking the strongest annual return since 2013. Easing trade tensions, Fed cuts, and durable economic data supported the rally. The index reached 35 new all-time highs last year, with 20 of those days coming in the last two months. US equities also bested other major global markets, outperforming the MSCI EAFE Index (+22%), MSCI Emerging Markets Index (+18%), and the FTSE 100 (+17%).

Source: Morningstar

  • The past decade has often been described as the most hated bull market in history (net flows into U.S. equities have been negative over the past 10 years). The S&P 500 posted an annualized return of 13.4% in the 2010’s, exceeding its 10% average annualized returns since its 1926 inception. We’ve since moved past 3200 on the S&P but a good reminder below of the challenges faced(and overcome) through the decade:

Source: Investopedia

  • This was the first decade ever without a technical bear market. The key word is technical, as the decade was not without its drawdowns – the market fell 19% twice in 2013 and 2018, narrowly missing the arbitrary 20% decline that defines a bear market. In 2019, the largest correction for the S&P 500 was only 6.8%, about half of the average year.

                                                                  Source: Compound Advisors


  • The 10th anniversary of the bull market has drawn parallels to the late 1990s. In 1998, the Fed delivered 75 bp of “insurance cuts” and the S&P 500 rallied by 27%. Valuations exploded from 18x to 23x and accounted for nearly all of the index return. Investors flocked to US stocks as global markets were in turmoil.


  • Given the parallels between 1998 and 2019, many investors are looking to history as a potential guide for the future. In 1999, the S&P 500 rallied by 20%. But in contrast with the late 1990’s, the current forward P/E of 19x is well below the 23x P/E at the start of 1999.


Asset Classes

As shown below in the gray boxes, diversification generally puts you somewhere in the middle of the return spectrum. That’s a feature not a bug, one we see as the first layer of portfolio protection.

The idea that anyone is going to consistently overweight to next year’s leading styles is crazy; building a structure that minimizes the drag of large losers is far more realistic.

2019 was solid across the board, and diversified portfolios should have had a good year. Adding an overlay to reduce exposures to areas of poor quality, negative momentum, and/or high valuation can bring additional protection beyond basic diversification.

In some years that protection isn’t necessary, but over a 20 – 30 year period all portfolios face periods of drawdown. A proactive plan to manage those periods can be the difference between meeting future spending needs or adjusting them.

                                      Source: J.P. Morgan Asset Management, Asset Allocation[1]


  • The story was Technology. All 11 sectors posted positive price returns in 2019 for the first time since 2010, with Information Technology the clear winner for the year and the decade. It drove nearly one-third of the S&P 500 total return for 2019, and over 20% for the decade. Energy was the biggest laggard in 2019 and the decade.
  • Fun Fact: In 2010, Exxon Mobil (XOM) was the largest company in the world (by market capitalization). Now, Apple (AAPL) is the largest. Not only is AAPL the biggest, but it is larger than the entire market capitalization of the Energy sector, including Exxon Mobil.


  • Valuation expansion drove nearly all of the S&P 500 return in 2019. Since 2009, earnings growth has been the primary driver of equities, accounting for 67% of S&P 500 returns. However, earnings growth explains just 8% of the S&P 500 return last year. Instead, three 25 bp Fed cuts helped lift company valuations. The S&P 500 forward P/E expanded from 16.5x to 19.4x and accounted for 92% of the index price gain.

                                                                    Source: Compound Advisors


Growth outperformed yet again in 2019, with the Russell 1000 Growth (+36%) topping the Value Index (+27%). For the decade, the Growth Index outperformed Value by a whopping 107% (+312% vs. +205%), leading in eight of ten years. Value also closed the year as the worst performing factor group.

                              Source: J.P. Morgan Asset Management. Returns > 1 yr not annualized

Fixed Income

Fixed income investors benefited from capital appreciation even as income from bonds vanished. Bond returns across the board were dominated by price return (aka falling rates and tighter spreads). 2019 was the best year for bonds since 2002. The three Fed rate cuts helped!

                                   Source: Bloomberg. Returns for dates: 1/1/2019 thru 12/31/2019

Historically income return has been a substantially larger contributor to fixed income total returns. The Aggregate Bond’s total return since 2003 has been comprised of nearly 80% income return. 2019 Price return at 65.2% was nearly 6x the 16 year average price return of 11.3%!

                                    Source: Bloomberg. Returns for dates: 1/1/2003 thru 12/31/2019

Durations of popular bond indices have crept longer… the 1.7-year increase in duration on the IG credit universe shown below might not seem like much. But a 1% (100bps) increase in interest rates raises the price risk of an interest rate move by ~2%. Strategically extending duration for a more attractive term premium is one thing but this increase in duration looks like a scramble to find yield.

                                                        Source: J.P. Morgan Asset Management.

Spreads on corporate and high yield bonds also tightened, providing a further boost to returns.

                                                                       Source: Strategas.   

Economic Review

  • Current U.S. economic expansion is now the longest in our history

  • However, the real annualized GDP growth achieved during the expansion is historically the lowest for an expansion since WW II.
  • Here’s what some major indicators seem to be signaling based on the data (Positive, Neutral, or Negative):
    • Consumer – Positive
    • Employment – Neutral
    • Housing – Positive
    • Manufacturing – Negative
    • Services – Positive
    • Inflation – Neutral
    • Central Bank Policy – Positive
    • Trade – Neutral


Please reach out for further detail on any of the above bullet points.

The Backdrop for 2020

 The Good

  • Central Banks threw water on the fire of the trade conflagration, boosting all assets in 2019; more is expected in 2020.
  • S. consumers are in good shape, buoyed by low unemployment, modest wage growth, and record stock prices.
  • Despite all-time highs for global markets, investors are not overly exuberant.

The Bad

  • 2020 began with a bang, literally.
  • While 2019 headlines were dominated by the trade war, 2020 threatens to start with actual war.
  • After a banner year, equities seem to be modestly overvalued.

The Ugly

  • Global manufacturing, burdened by trade uncertainty, has inflected lower.
  • S. corporate debt is both lower quality and longer duration than any time in the past 30 years, exposing investors to both interest rate and credit risk.


Past performance is not indicative of future results. This material is not financial advice or an offer to sell any product. The information contained herein should not be considered a recommendation to purchase or sell any particular security. Forward looking statements cannot be guaranteed.

This commentary offers generalized research, not personalized investment advice. It is for informational purposes only and does not constitute a complete description of our investment services or performance. Nothing in this commentary should be interpreted to state or imply that past results are an indication of future investment returns. All investments involve risk and unless otherwise stated, are not guaranteed. Be sure to consult with an investment & tax professional before implementing any investment strategy. Investing involves risk. Principal loss is possible.

Advisory services offered through Aptus Capital Advisors, LLC, a Registered Investment Adviser registered with the Securities and Exchange Commission. Registration does not imply a certain level or skill or training. More information about the advisor, its investment strategies and objectives, is included in the firm’s Form ADV Part 2, which can be obtained, at no charge, by calling (251) 517-7198. Aptus Capital Advisors, LLC is headquartered in Fairhope, Alabama. ACA-20-02

[1] The “Asset Allocation” portfolio assumes the following weights: 25% in the S&P 500, 10% in the Russell 2000, 15% in the MSCI EAFE, 5% in the MSCI EME, 25% in the Bloomberg Barclays US Aggregate, 5% in the Bloomberg Barclays 1-3m Treasury, 5% in the Bloomberg Barclays Global High Yield Index, 5% in the Bloomberg Commodity Index and 5% in the NAREIT Equity REIT Index.

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