Good news for secular bull: fundamentals on a stampede
Policy errors and Fed could pose problems later but it’s full steam ahead for now.
We remain bullish on equity markets into year-end, especially the so-called “cyclical/value trade” after its recent healthy correction of 5% to 10%, depending on the stock, and are holding to our longstanding S&P 500 targets of 4,500 for this year and 5,000 for 2022. Longer term, we think the outlook depends on the Fed and the possibility of a policy error. But either way, the 2021-22 outlook is very positive. We’ve just raised our 2023 S&P earnings forecast to $235, with nominal GDP this year and next likely to approach 15% cumulatively, driven by four accelerants:
- A roaring economy We had the most unusual recession in history. The economy did not drop in 2020 for natural organic reasons but due to government lockdowns and Covid-19. Few high-paying jobs were even lost. With the Fed and Congress reacting with record-setting stimulus, we entered a recovery with cash piled everywhere and animal spirits hyped by the lifting of the long lockdown. After a decade of capex cutbacks, commodities generally are in short supply against this demand backdrop and “help wanted” signs are posted up and down Main Streets around the county. Wage rates are rising, further fueling consumer confidence. We are in a virtual upward cycle that we think has at least another 18 months to play out.
- Earnings exploding to the upside Q2 reporting season is off to a good start, with big beats by the major banks. In general, our analysts expect second-quarter earnings to be extremely strong, with more confident guidance as well. Though we are looking for some near-term margin pressure, particularly in staples, most companies may still beat on earnings simply because their top-line revenue beats will be so high. We expect S&P earnings for 2022 and 2023 to hit $220 and $235, respectively. As we move through the back half of this year, these next two years will increasingly come into focus.
- Covid resurgence worries overdone Although the Delta variant certainly is dangerous, the vaccines in place appear to be very effective in limiting hospitalizations and deaths from it among vaccinated people. And vaccine rollouts are accelerating around the world, with Europe, China and Japan moving quickly to catch up to the U.S. We expect by fall, the European and Japanese economies will reaccelerate like ours did when the masks came off. By then, with vaccine production fully ramped up in all the mature economies, vaccine shipments to the emerging world should really step up. We think this course of events will effectively be like booster rockets going off in succession through fall and winter, keeping U.S. growth at a higher level than most analysts expect.
- Fed still a catalyst—for now Chair Powell and his team keep pouring more liquidity onto the fire, which is why we think the recent drop in Treasury yields will prove temporary. We hailed the Fed’s forceful response to the pandemic in 2020, providing what the country’s capital markets needed to prevent an economic meltdown amid the sudden worldwide economic outage. Now, however, we think it runs the risk of policy error by not acting fast enough to reign in the inflationary forces clearly upon us. Although we expect policymakers over the course of summer to start setting the stage for taper later this fall and rate hikes in late 2022, we think this cautious course frankly may be too timid to rein in the overheating U.S. economy. Once we get through present short-term technical factors driving yields lower (particularly the temporary dearth in new issuance by the U.S. Treasury), yields should begin rising again. We expect to see the 10-year at 2.5% by year-end, with inflation continuing to run well above the Fed’s 2% target. A 10-year Treasury that tops out around 2.5%-3% would be just fine for equities. The concern is, will yields stop there? For more on the risk of Fed policy error, see my recent market memo.
In sum, the back-half outlook for this year is strong. We continue to favor the cyclical sectors that most benefit from an economic upswing, are the cheapest stocks in the market today and are less impacted by the expected rise in Treasury yields. All these stocks have recently corrected and are now bouncing. This is a good time for investors to reload, with an eye particularly toward commodities, energy, banks, autos and semiconductor names. With fundamentals on a stampede, this secular bull remains on a run.