Stocks are definitely cheaper on paper than they've been in a while, though that cheapness will only be validated if earnings next year don't roll over too much harder than current expectations.
Citigroup strategist Tobias Levkovich calculates that the S&P 500 right now builds in an implicit forecast of zero earnings growth next year (subject to several assumptions about "fair value" under current conditions). If so, that would mean the market is building a cushion against some tougher times, but the process of analysts chopping down quarterly forecasts from the current expectation of 8 percent profit gains would not likely please investors along the way.
The free-cash-flow yield of the S&P 500 based on the past year's results — simply the inverse of the price-to-free-cash-flow ratio — is approaching levels it reached toward the end of the grinding, multistage downturn of 2015-2016. (The higher the FCF yield, the lower the valuation.)
That was another period that got into the gray area between "correction" and "virtual bear market" and gave way to a two-year rally helped first by a dovish central bank response then the presidential election surge in confidence, growth expectations and tax cut anticipation.
But the offset now is a higher cost of corporate capital, especially reflected in higher borrowing rates on the lowest tier of investment-grade bonds, rated triple-B.
Higher corporate debt yields, all else equal, will restrain equity valuations. Entering 2019, a lot of anxiety is focused toward corporate credit as a key headwind, even though there is not a fearsome percentage of that debt that needs to be paid down or refinanced next year. Whether the markets are over-anticipating a credit-stress buildup or properly handicapping a stingier credit backdrop is pretty much the fulcrum of the bull—vs.—bear story for next year.
Levkovich also did a survey of institutional clients, in which they predicted around 4 percent 2019 S&P 500 earnings growth — about half the consensus analyst forecast right now. These professional investors now see the S&P 500 finishing 2019 at 2,850. Sure, that's up nearly 10 percent from here but is 100 points lower than the prior survey in late September.
This fits with other gauges of investor mood (weekly retail-investor polls, futures positioning, a New York Times Sunday Styles section feature foretelling a coming financial crash) showing market participants are concerned and defensive, but not all-out fearful. By bull market rules, sentiment is cautious enough to substantiate the case for a rebound rally soon.