Forget last year — why a year-end stock market rally could happen in 2019

When it comes to stock market forecasting, it's trendy to be pessimistic. Because major equity benchmarks like the S&P 500 have always gone up over long periods of time, television audiences and newspaper readers won't be impressed by portfolio managers professing the Dow will gain 8% to 10% in the year ahead.

On the other hand, a hedge-fund founder proclaiming cataclysm is around the corner may prove inaccurate, but in the financial industry, bulls usually earn the profits and bears usually earn the attention.

There are reasons to be concerned. Economic growth around the world is slowing and the U.S. economy is not immune to those forces. American manufacturing and export data released this month showed the weakest numbers since 2009. Surveys of consumer confidence indicate ongoing trade wars have eroded some trust in the U.S. economy, which could affect consumer spending. The House has begun impeachment inquiries and political noise will continue to increase as we near a presidential election year. On top of that, most investors remember the sting from this time a year ago when equities fell 20% peak-to-trough from September until Christmas.

It sure feels like the prediction pendulum has swung lower for both economic experts and the investing public. Recession warnings and correction calls are as fashionable as ever. As for us, we consider it more likely than not that the market grinds higher through year-end.

Just because you have heard it a dozen times doesn't mean it's not true. In less than 12 months, the Federal Reserve has gone from a tightening cycle, into a holding pattern, to an easing period. This is the single biggest difference between the fourth quarter of 2018 and the fourth quarter this year. Fed Chairman Jerome Powell has already announced two 0.25% cuts to the Fed Funds rates since July and we will likely see a third cut before year-end.

It's true that the Fed is depressing interest rates because economic weakness is a concern. It's also true that lower rates and accommodative central bank policy will increase the longevity of this economic expansion. A friendly Fed does not guarantee stock prices will move higher, but it will reduce the depth of a potential correction and discourage the movement of investment dollars into conservative assets offering especially low yields.

Political rhetoric and Trump tweets aside, there have been precious few signs of legitimate progress in negotiations between the U.S. and China since this trade war began. The biggest developments have been temporary truces that delayed additional tariffs. Finally, however, there are signs a bigger breakthrough could be coming.

Seasonally speaking, November and December tend to be among the best-performing months for the S&P 500 as consumer spending — the largest component of GDP — spikes during holiday shopping season. Recency bias leads us to focus on the ugly finish to 2018, but statistically that was an outlier. The S&P 500 rises 4.3% on average in the fourth quarter, the best of any calendar quarter. By comparison, the third quarter is historically the worst period of the year with average returns of -0.1%. In other words, a sluggish summer (like the one we just experienced) does not prevent equities from performing well late in the year.

From Jan. 1 through Oct. 15, the S&P 500 has risen 21% (including dividends). That's more than twice the average annual gain for U.S. equities, which leads some to conclude stocks are due for a correction.

Guess what? Stocks don't know their year-to-date returns. Likewise, the fact this economic expansion is the longest in history isn't particularly meaningful. Bull markets don't die of old age.

Some investors might be surprised to learn the S&P has gained less than 7% in the past 12 months. If you avoid cherry-picking a convenient time period, the market may appear less overheated.

There's no guarantee, of course, that stocks establish new all-time highs in the immediate future, but the smart move is to remain invested. It would be a mistake to drastically reduce equity exposure before year-end.