Monthly Market Commentary
The Case for Equities in 2021
Philip Blancato, Chief Market Strategist, Advisor Group
Fueled by optimism coming out of a recession and a reopening economy, it does not come as a surprise that domestic equity returns in 2021 have been exceptional, with the S&P 500 up over 20% year-to-date . As the U.S. stock market continues to post new all-time highs, it raises questions about the sustainability of the equity rally we have seen since hitting a bottom in March of 2020, and whether the market has gone too far in too short of a period. After all, pull-backs in equity markets are normal; Since 1945, there have been 84 declines in the S&P 500 between 5-10%, with an average decline of -7%. However, these pullbacks tend to be short term in nature, with an average length of decline and time to recover of one month . While pullbacks are normal and we would not be surprised to see one in the short term, we are currently constructive on the U.S. equity market for a variety of reasons.
While a 20% gain from the S&P 500 seems exceptional, the earnings growth we have witnessed so far has justified the move higher. For the second quarter of 2021, the blended earnings growth rate for the S&P 500 is 89.3%, with only a handful of companies remaining to report. If 89.3% is the growth rate for the quarter, it will be the highest growth rate reported by the index since the fourth quarter of 2009, coming out of the Financial Crisis. It’s also encouraging to see the breadth of earnings growth, as all eleven sectors have reported positive growth so far. While earnings in the second quarter were strong, what will ultimately drive stocks higher are future earnings. Expectations for the remaining two quarters of the year are for growth of more than 20% in each period.
At 26.92 times earnings, the current price-to-earnings (P/E) ratio for the S&P 500 is above its long-term average multiple of 19.39. While U.S. equities do not appear inexpensive, current valuation levels may be sustainable. Earnings growth should continue to make the “E” in P/E more reasonable, especially if earnings continue to come in above expectations. As an example of the effect of strong earnings growth on valuation multiples, the P/E ratio for the S&P 500 reached a peak of 30.55 in February this year, and even though stocks have kept rising in price, the P/E for the index has come down.
Beyond the fundamentals, there are several macroeconomic factors that are supportive of equities. First, it appears that the U.S. economy is in the early stages of recovery from the recession in 2020. The early stages of a business cycle are characterized by rapid growth in output and profits as companies benefit from easy monetary policy and expanding credit. The Federal Reserve has signaled that they intend to keep the Federal Funds Rate anchored at zero, which allows companies to take advantage of historically low borrowing costs. Lastly, the U.S. consumer remains strong; The personal savings rate remains elevated at 9.4%, which should allow US consumers to increase discretionary spending in the coming months.
While we believe that stocks will continue to move higher from here, there are risks in the short-term that may spur volatility. For instance, the Federal Reserve is expected to announce that they will begin tapering their bond purchasing program in the coming months, which has not been received positively by markets in the past. Though we don’t think it is likely, should the Fed announce that the timing and amount of tapering is more aggressive than anticipated by the market, it could have a negative impact on risk appetite in the short term. Another area of concern is the rising Coronavirus case levels brought on by the Delta variant, which threatens to slow the pace of the economy reopening. While the Delta variant is a concern, as it has become the dominant strain in the U.S., we still believe the United States remains on pace for above trend GDP growth for the remainder of 2021. All told, despite the current short-term risks, we consider the present environment supportive for equities and maintain an overweight stance within our portfolios.
1 Morningstar Direct (as of 8/24/2021)
4 Bloomberg (as of 8/24/2021)
GDP: Gross domestic product (GDP) measures the final market value of all goods and services produced within a country. It is the most frequently used indicator of economic activity. The GDP by expenditure approach measures total final expenditures (at purchasers’ prices), including exports less imports. This concept is adjusted for inflation.
Personal Savings Rate: Personal saving as a percentage of disposable personal income, frequently referred to as “the personal saving rate,” is calculated as the ratio of personal saving to DPI. Personal saving is equal to personal income less personal outlays and personal taxes; it may generally be viewed as the portion of personal income that is used either to provide funds to capital markets or to invest in real assets such as residences.
P/E Ratio: A fund’s price/earnings ratio can act as a gauge of the fund’s investment strategy in the current market climate, and whether it has a value or growth orientation. Companies in those industries enjoying a surge of popularity tend to have high P/E ratios, reflecting a growth orientation. More staid industries, tend to have low P/E ratios, reflecting a value orientation. Morningstar generates this figure in-house on a monthly basis, based on the most-recent portfolio holdings submitted by the fund and stock statistics gleaned from our internal equities databases. Negative P/Es are not used, and any P/E greater than 60 is capped at 60 in the calculation of the average.
The Federal Reserve System: The central bank of the United States. It performs several general functions to promote the effective operation of the U.S. economy and, more generally, the public interest.
S&P 500: The S&P 500® is widely regarded as the best single gauge of large-cap U.S. equities and serves as the foundation for a wide range of investment products. The index includes 500 leading companies and captures approximately 80% coverage of available market capitalization.
Index performance does not reflect the deduction of any fees and expenses, and if deducted, performance would be reduced. Indexes are unmanaged and investors are not able to invest directly into any index. Past performance cannot guarantee future results.
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