The stock market keeps setting new highs in a rally no one saw coming

Key Points
  • Nearly everyone on Wall Street underestimated the strength of this year's stock market.
  • Of 17 analysts that CNBC tracks, only three have price targets ahead of where the S&P 500 traded Monday.
  • Investors have been spooked this year by myriad headwinds, but the market has continued to set records, including a fresh high for the Dow industrials Monday.
Dow reaches a record high — Watch three experts debate what investors should expect
Dow reaches a record high — Watch three experts debate what investors should expect

Faced with an array of daunting headwinds and coming off a tough year, Wall Street took a dim view of stocks in 2019. As a result, many major analysts missed one of the best years of this history-making bull market that continues to make new highs.

Of the 17 forecasters that CNBC tracks for S&P 500 price, just three have targets that are above where the broad market index traded Monday. The median 3,000 target is 2.7% below midday levels with still nearly two months left in the year.

While the market's path is always unknown and could come back down before the calendar turns to 2020, the year looks like an opportunity lost for those who bought into the pessimism. The S&P 500 continues to climb to new highs, while its sister index, the Dow Jones Industrial Average, also set a new high-water mark Monday.

Dow hits a new all-time high on trade optimism, October jobs report
Dow hits a new all-time high on trade optimism, October jobs report

The Dow is approaching an 18% gain for the year while the S&P 500 has climbed close to 23% and even the small-cap Russell 2000 is ahead more than 18%.

"I don't think you can blame people for being a bit cautious or skeptical," said Sam Stovall, chief investment strategist at CFRA Research. "If anything, earnings growth for this year has come down, and earnings expectations for next year have come down."

Indeed, the S&P 500 is in the midst of an earnings recession that is on track to show the third consecutive quarter for negative year-over-year growth. Despite a 76% beat rate compared with expectations, earnings are still projected to show a 2.7% decline in the third quarter, according to FactSet.

But it's been more than that this year.

A range of opinions

Wall Street has been spooked by concerns over a potential recession, the U.S.-China tariffs and multiple geopolitical concerns such as how Brexit will turn out.

Still, the market keeps going higher and defying the naysayers. The "most hated bull market in history" observation so often repeated on Wall Street may have become the worst cliche in bull market history as the averages continue to push into record territory.

"You do wonder what is causing the market to go higher. One [factor] is that the lack of alternatives continues," Stovall said, citing the "TINA" belief that There Is No Alternative to U.S. stocks.

Stovall is among the many Wall Streeters who underestimated the market's strength. He put a 2,975 target on the market, but was by far not the most pessimistic. UBS is the lowest on the Street with a 2,550 price target while Morgan Stanley has been consistently bearish with its 2,750 estimate.

In fact, Morgan Stanley is not only bearish on 2019 but believes low returns will continue for the next decade due to high valuations. Andrew Sheets, chief cross-asset strategist at the firm, said returns will be "challenging" considering the set-up from the trailing price-to-earnings ratio.

On the other side, though, are strategists including Piper Jaffray's Craig Johnson, who has been one of Wall Street's biggest bulls for years and holds a 3,125 target for the S&P 500. Though directionally right about the market's moves, Johnson said "we weren't perfect all along" in terms of timing, and he understands the skepticism about valuation.

"I think a lot of investors are struggling with valuation. The way this market has moved up, stocks have been pretty darn expensive," Johnson said. "A lot of investors got caught off guard in Q4 last year. Those memories are still fresh in their minds about the big, dramatic selloff which wiped out a lot of bonuses for people last year. There's that psychological impediment."

Money to the mattresses

The fourth-quarter sell-off last year was fueled by weakening economic growth coupled with a Federal Reserve that seemed tone-deaf to what was happening, Two verbal miscues from Fed Chair Jerome Powell that pointed to tighter policy ahead fueled the belief that a year when the market fell 6.2% could bleed over into 2019.

Investors reacted by heading for cover.

Money market fund balances have surged this year to $3.5 trillion, the highest in a decade and up 23.7% year to date. Retail investors alone have pushed $324 billion into money markets in 2019, a 32% jump.

Sentiment has been turning of late, though, if not among the big Wall Street houses then at least with the mom and pop crowd that has been cheered by three Fed rate cuts and a macro scenario that no longer looks as gloomy as it did a few months ago. Bullishness, or the belief that the market will be higher in six months, was at a 12-week high of 35.6% in the most recent American Association of Individual Investors survey, while the bears fell to 28.3%.

Among professional investors, though, skepticism remains high.

The put-call ratio, a measure of sentiment among options traders, has remained above 1 since mid-September, a contrarian indicator that the market could be headed higher due to strongly negative sentiment.

"There's worry that we are going to be disappointed by the trade issue, economic data and earnings," said Quincy Krosby, chief market strategist at Prudential Financial. "Nothing stays the same forever. We've started to see an easing in all of the above. It doesn't mean that's the perfect scenario for the market, but it is perfect enough to get volume and breadth beginning to pick up."

For the bulls, one of the big factors could simply be that the signs of a recession that had shot up during the summer have been tamed.

The bond curve inversion, where shorter-dated yields were higher than their longer-term counterparts, has since reverted. Inversions have preceded each of the last seven recessions, but there's some sentiment that this time could be different due to unusual factors playing out in the bond market, even though fourth-quarter GDP growth looks like it will struggle to top 1%.

In any event, lack of a recession threat would be one huge load lifted from a market that has struggled to inspire confidence all year.

"The tug-of-war has not died down. There are those who still see that there is a recession looming and the market is oblivious to that," Krosby said. "The fact of the matter is the market is suggesting there is not a recession that's imminent, that the market was poised for recession for too long."

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