Correction odds rise but long-term outlook strong Correction odds rise but long-term outlook strong http://www.federatedinvestors.com/static/images/fhi/fed-hermes-logo-amp.png http://www.federatedinvestors.com/daf\images\insights\article\road-pine-trees-small.jpg October 20 2021 September 20 2021

Correction odds rise but long-term outlook strong

A near-term pullback could represent an opportunity for long-term investors.

Published September 20 2021
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This morning's volatility could mean the market correction that began two weeks ago is accelerating into the 5-10% pullback we’ve been expecting. But our advice for long-term equity investors remains the same: view a correction as an opportunity to add, particularly in cyclical stocks, many of which already have corrected by 10% to 20%. We believe these stocks will lead the market higher into the new year and are sticking with our recently raised S&P 500 targets of 4,800 for year-end and 5,300 for 2022. In the very near term, we think the current pullback could easily deepen to 10% before sentiment is washed out and the stage is set for the next advance. (It’s interesting to note a full 10% correction would take us to 4,100 on the S&P, the 200-day moving average.) Large-cap growth stocks that have carried the market the last several weeks are likely to be hurt the most if the correction continues. 

Potential sources of a near-term correction:

  • China China’s policymakers clearly are playing long ball, with one industry after another coming under review. This is having near-term negative consequences for markets but, at least from the perspective of Chinese authorities, offers potentially more positive long-term outcomes as their desired structural changes are implemented. It started with fintech, moved to cram-school operators, then to gaming and gambling, and now real estate. Because China is broadly self-funded, we think it can accomplish its goals without transmitting a financial crisis to the global economy. Nonetheless, it’s big enough to spook global markets that had been way overbought.
  • Reopening delay The delta variant’s spread, as well as accompanying restrictions and renewed Covid fears, have stifled some activity in high-touch service industries such as restaurants and travel. Recently announced employer mandates from the Biden administration and the State of New York have added to the confusion, causing a temporary pullback in activity, and corporate travel has not picked up the baton from the summer tourism season as had been expected. All of this is leading to softer growth in GDP and earnings in Q3. And with the initial psychological stimulus of the nationwide reopening earlier this summer now abating, animal spirits are calming down from their peak.
  • Biden's economy-slowing tax-and-spend plan prospects rising The House bill’s key elements are now public and if passed as is, would lead us to lower our S&P earnings outlook for 2022 by about $12/share, as well as cut half a point off our longer-term GDP forecasts. We are increasingly anticipating that some form of this bill does get passed, perhaps with some mild window dressing added to provide air cover for moderate Democrats such as Joe Manchin. Up to now the market had been skeptical of passage; it is now reassessing.
  • Fed tapering soon Despite last week’s unexpectedly low CPI print, our read on what is happening with all the moving parts that go into the inflation numbers continues to suggest a Fed taper beginning later this year. We also think it is likely a couple more of the “dots” released from this week’s meeting move into the 2022 first rate-hike camp. Because the Fed’s QE program has a direct effect on the supply and demand for Treasuries, it is likely yields finally will begin to move higher once taper starts. This could negatively impact the long duration large-cap growth stock valuations that now make more than a quarter of the S&P.

Reasons we are sticking with our more optimistic year-end and 2022 market forecasts:

  • “When,” not “if” The economic reacceleration we’ve been expecting, though delayed by delta, is coming soon; it’s a matter of “when,” not “if.” The economy’s fundamentals are strong, and prospects of a recession seem distant. Valuations on the so-called “reopening stocks” do not fully reflect this reality.
  • Global economy playing catchup The global economy has lagged the U.S. recovery due to slower vaccine rollouts. As those programs gain traction, and in some cases move ahead of the U.S., the reopening trade of Europe, Asia and the emerging markets could fire off like sequential rocket boosters, starting this fall and carrying through much of 2022.
  • Earnings remain healthy and growing While earnings growth is slowing, the level of earnings continues to expand mightily. Even with the Biden corporate tax hikes, S&P earnings next year and in 2023 are likely to reach $220 and $240 per share, respectively. That would reflect solid 8-10% growth off 2021’s already much improved outcome.

For all the reasons stated above, we remain bullish and tilted toward the more cyclical sectors of the market, where valuations are cheap, earnings estimates have the most upside and most stocks have already corrected significantly. And if the deeper market correction comes to pass, we believe it will represent a good opportunity for investors to reload, particularly in travel and leisure industries as reopenings pick up, autos and semiconductors as supply chain bottlenecks ease, and Financials, Energy, Materials and Transports sectors as global economic activity reaccelerates.

Tags Equity . Markets/Economy . Politics . Monetary Policy .
DISCLOSURES

Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

Bond prices are sensitive to changes in interest rates, and a rise in interest rates can cause a decline in their prices.

Consumer Price Index (CPI): A measure of inflation at the retail level.

Gross Domestic Product (GDP) is a broad measure of the economy that measures the retail value of goods and services produced in a country.

Growth stocks are typically more volatile than value stocks.

International investing involves special risks including currency risk, increased volatility, political risks, and differences in auditing and other financial standards. Prices of emerging-market and frontier-market securities can be significantly more volatile than the prices of securities in developed countries, and currency risk and political risks are accentuated in emerging markets.

S&P 500 Index: An unmanaged capitalization-weighted index of 500 stocks designated to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. Indexes are unmanaged and investments cannot be made in an index.

Stocks are subject to risks and fluctuate in value.

Federated Global Investment Management Corp.

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