Stock Market 2020: A 10% correction could be coming, Wells Fargo warns

[9Pardhu]

As the end of the year and the decade approaches, Wall Street strategists have been delivering their expectations about where the stock market will close out 2020.

The next year will bring with it myriad market-moving events, including the 2020 presidential elections and next phases in U.S.-China trade relations. Market pundits across Wall Street have each delivered their ideas for how these and other catalysts will shape equity markets in 2020.

Their theses come as stocks have flirted with fresh record highs time and again in the fourth quarter of 2019, as global growth concerns receded from a fever pitch earlier this year. As of mid-November, the S&P 500 was up more than 23% for the year-to-date.

Here’s a summary of what some of Wall Street’s top strategists are telling their clients for next year, updated as new 2020 views become available.

Wells Fargo (Target: 3,388; EPS: $166) –  Recession risks in the rearview mirror, but a correction could be coming

Over the past couple months, strategists’ expectations for a market “melt-up” early next year have far outpaced fears of a recession from earlier this year. The swift about-face in sentiment, however, could pose a risk to markets in 2020, according to Wells Fargo.

Since the stock market sell-off this past August, “the frequency of Bloomberg ‘r-word’ mentions are down nearly 70% and the VIX Index has retreated to 40% below its long-term average,” Chris Harvey, Wells Fargo Chief Equity Strategist, wrote in a note. “The last time sentiment felt this positive (4Q17, on the heels of tax reform) stocks initially rallied in 1Q18 before running head-first into a 10% correction.”

For 2020, investors should brace for a more volatile equity market, Harvey said. With the VIX (^VIX) volatility gauge back down around 12 and investment-grade credit spreads shrunken down to about 100 basis points, “we see material scope for an upward move,” he added. 

“A 10% stock market correction in 1H20 is possible; we can envision one in late March/early April when the Fed’s balance sheet possibly stops growing,” Harvey said, with emphasis his. “If we do see a healthy equity sell-off in 1H20, we would buy weakness, all else equal. Until that time, we recommend reducing portfolio risk slowly and opportunistically.” 

 

 

With this in mind, Harvey downgraded semiconductors to Neutral from Outperform, noting that “this high-risk, early-cyclical group has outperformed expectations and many of the reasons for the upgrade have already played out.” On the other hand, the value group of REITs has underperformed the market since June “and is approaching technically oversold levels,” Harvey added. 

Wells Fargo’s price target of 3,388 suggests stocks will ultimately end slightly higher next year, with gains mostly held back by still-sluggish increases in company profits.

As Harvey points out, most of the S&P 500’s 27% gain for the year-to-date was driven by a price-to-earnings multiple expansion, meaning stocks have gotten more expensive in absence of major earnings growth. This, in turn, was driven by declines in both Treasury yields and credit spreads this year – neither of which will likely continue next year, Harvey said.

 “We take a more conservative stance on 2020 EPS growth,” Harvey said. “A number of economic factors that are positively correlated with EPS growth should improve: ISM [manufacturing purchasing managers’ indices], ISM Services, and capacity utilization.”

“However, other factors will likely be neutral-to-negative: credit spreads, volatility, and unemployment,” he added. “The net result is an SPX EPS estimate of $166, or 5% growth from the current estimate of $158.50.”

Wells Fargo price target introduced December 19, 2019

[tacobell fan]

[Hydrockers]

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[xano917]

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[Thokkalee]

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[xano917]

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