The Tell: S&P 500 earnings upside in 2020 will ‘primarily depend’ on U.S.-China trade deal, says JP Morgan

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The current bull market may power along for another year, but the growth of corporate profits “will primarily depend on the magnitude and timing of trade deals,” according to Dubravko Lakos-Bujas, JPMorgan’s top U.S. equity strategist.

Lakos-Bujas estimated that the U.S.-China trade standoff has already had a major impact on stock valuations, with the first-order effects of new tariffs reducing collective profits of companies in the S&P 500 index SPX, -0.11%  by $6 per share.

“The total impact, including…lower business investment/[capital expenditures], inventory destocking, weaker commodity [prices] and a stronger U.S. dollar” have reduced earnings-per-share, or EPS, by $12, he argued in a research note to clients that unveiled his outlook for 2020. The strategist’s current 2020 EPS estimate is $180, which would represent a 10% year-over year increase from 2019 EPS projections of $163.63.

By that measure, corporate profits would be more than 7 percentage points higher than the roughly 1% advance seen thus in 2019.

Lakos-Bujas speculates that the Trump administration will eventually strike a deal that leads to a partial rollback of U.S. and Chinese tariffs, and that this move — combined with a “global cycle recovery, pro-growth election year rhetoric and neutral investor positioning,” will push the S&P 500 to 3,400 by year’s end, or 8.4% above Monday’s closing price.

The market appears to agree with JPMorgan on the importance of a U.S.-China trade deal, as the Dow Jones Industrial Average DJIA, -0.10%, S&P 500 and Nasdaq COMP, -0.07%  have whipsawed in recent sessions on each piece of trade news.

In his 2020 outlook, Lakos-Bujas also predicted that volatility will remain low, with a fair value of the Cboe Volatility Index VIX, +0.50% —which uses S&P 500 options trading to reflect the market’s expectation for volatility in the coming 30 days — at between 14 and 15, below its historical average of about 19. He argued that loose central-bank monetary policy will support low volatility and higher equity prices.

In terms of politics in the election-year ahead, “We think that the two most likely outcomes are Trump’s re-election or an experienced centrist Democrat, which would be neutral or positive for markets (at least initially),” he wrote. “A progressive left Democratic candidate could be a significant downside risk for the market; however, we assign a low probability to this outcome,” he added.

Meanwhile, he recommended that investors expect the recent rotation into value stocks to continue in 2020, “as the global business cycle reaccelerates and puts upward pressure on bond yields and commodities,” Lakos-Bujas said. “History implies the current rotation is still less than half-way through.”

The house view at JPMorgan is that, on a sector level, energy, materials, industrials and communications-services will outperform the broader market, while the defensive sectors of consumer staples, utilities, and real estate will underperform.