How the Dow could zoom past 31,000 by the end of 2020

America's stock market is on fire, registering its best start to a year since the dotcom bubble days of the late 1990s.

America’s stock market is on fire, registering its best start to a year since the dotcom bubble days of the late 1990s.

The Dow’s ascent above 27,000 has been propelled in large part by the Federal Reserve’s rapid pivot from rate hikes to potential cuts. That historic shift has made stocks look even more attractive than bonds, and raised confidence that the longest economic expansion on record will continue.

Ed Yardeni, president of investment advisory Yardeni Research, believes the Dow could zoom to 31,500 by the end of next year or even sooner.

But his bullish call isn’t based squarely on economic fundamentals. Instead, Yardeni believes it’s all about President Donald Trump’s evolving trade war giving the Fed no choice but to reintroduce easy money.

“Trump has figured out the perfect way to force the Fed to lower interest rates. All he has to do is keep creating uncertainty about US trade policy,” Yardeni wrote in a recent note to clients.

Fed chief Jerome Powell explicitly called out trade uncertainty as the main risk to the American economy — a risk so great that the US central bank has signaled looming rate cuts. And Trump knows this.

Yardeni suggested that Trump could keep trade negotiations open and continue to alternate his message about how those talks are going.

“The more uncertainty, the better to get the Fed to lower interest rates,” Yardeni said.

And then the Trump administration could declare victory in the global trade war later this year or early next, lifting stocks further.

Under that scenario, Yardeni anticipates the S&P 500 will cruise to 3,500 by the end of 2020 — or sooner. That roughly translates to 31,500 on the Dow.

“It’s all about winning a second term and playing Powell to do so,” Yardeni wrote.

Best start since 1998

US stocks are already sitting at record highs. The S&P 500 came into this week with a 20.2% gain on the year, the biggest for this point on the calendar for any year since 1998, according to Bespoke Investment Group. It’s also the ninth strongest move since the S&P 500 began in 1928.

History shows that these kinds of gains are hard to build on.

During the eight previous moves of 20%-plus, the S&P 500 has posted an average gain of just 0.35% during the year’s remaining months, according to Bespoke. And half the time the market posted an outright loss.

Some analysts are warning that euphoria over the Fed’s looming rate cuts may be misplaced.

“Markets have extremely steep monetary easing expectations for the next 12 months,” Seema Shah, chief strategist at Principal Global Investors, wrote in a note to clients. “The Fed has only ever delivered such aggressive policy loosening when the US economy was already in recession.”

Shah noted that while a slowdown is underway, a recession is not the firm’s base case.

1 in 3 chance of a US recession

The New York Fed’s US recession model, which is based on the difference between long-term and short-term rates, estimates there is a 33% chance of a recession within the next 12 months. That’s the highest level for this model since the economic expansion began more than a decade ago. Recessions occurred the last three times this indicator climbed above 30%.

The question for stocks is whether the Fed can engineer a soft landing in the US economy. That would likely drive a rebound in the economy that lifts corporate profits, justifying future gains in the stock market.

Morgan Stanley doesn’t think that will happen.

Michael Wilson, Morgan Stanley’s equity strategist, warned in a note on Sunday that the S&P 500 will fail to break above the 3,000 level because of looming declines in earnings and potentially a slumping US economy.

“The fundamentals are no longer strong,” Wilson wrote.

Wall Street is bracing for its first earnings recession in three years.

After falling slightly during the first quarter, S&P 500 per-share profits are projected to shrink by 3% during the second quarter, according to FactSet. And another slight decline is expected for the third quarter.

However, analysts are penciling in a recovery after that, with fourth-quarter profits projected to grow by a healthy 6%.

Wilson argued that consensus earnings forecasts are “still materially too high” for the second half of 2019 and 2020.

“The Fed’s recent signaling of a cut later this month should not be celebrated if this is accompanied by earnings, and possibly an economic recession in the US,” Wilson wrote. “History is clear on this one.”

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