Welcome to RBC’s Markets in Motion podcast, recorded May 7th, 2021. I’m Lori Calvasina, Head of US Equity Strategy at RBC Capital Markets. Please listen to the end of this podcast for important disclaimers.
This week in the podcast, we discuss changes in our outlook for the S&P 500. The big thing you need to know: earlier this week, we lifted our 2021 S&P 500 price target to 4325, up from 4,100. We’ve also lifted our EPS forecasts for this year and next, and bake in corporate tax hikes to our 2022 number. Overall, we see a little more room for stocks to climb higher this year, but we also continue to expect a pullback or heightened volatility in the market before the year is done, capping that upside.
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Now, the details.
Let’s start with our S&P 500 price target. Earlier this week, we raised it to 4325, up from 4,100.
- As our regular listeners know, when it comes to our targets, it’s all about how the math shakes out.
- Our new target is close to the median and average of 11 different upside scenarios/tests that we examined.
- It comes closest to four of those tests in particular:
- First, our GDP range test, which highlights how stocks perform during and prior to different kinds of GDP backdrops. On this analysis, we find that the full year gain in the S&P 500 in years before 4% real GDP occurs averages 16%. This implies a move to 4357. Consensus forecasts for 2022 are currently tracking at 4% and have been stable.
- Second, our GDP regression model, which implies that the S&P 500 will end up at 4313 based on current consensus forecasts through year end 2021.
- Third, one of our forward P/E tests, which implies a move to 4320. This particular P/E test assumes that the forward P/E in the S&P 500 will modestly expand from 20.1x to 21.6x, using our new EPS forecasts of $187 for 2021 and $200 for 2022.
- Driving this test is some work we’ve done illustrating how the forward P/E of the S&P 500 has been anchored to the Fed’s balance sheet since the Financial Crisis, and our assumption it will expand by a similar rate between now and year end 2021 that it has over the past six months – which has been an extremely modest pace.
- This has been the most controversial part of our call, but we don’t think that it should be – it essentially captures the idea that monetary policy has been propping up risk assets and the P/E of the S&P 500 specifically.
- Fourth, the view of our technical strategy team that 4330 is an important intermediate upside level in the S&P 500 to monitor. The team has provided us with a number of upside and downside scenarios that we use in our targeting process and this is one of the upside scenarios they pointed us to. As of Monday, 4330 was trendline resistance drawn off of the September and October, 2020 highs.
- It’s worth noting that we consider 4325 to be our new base case. Two of our scenarios point to a move to 4500-4600 – that’s our bull case if 4325 ends up being too conservative.
Moving on to our earnings forecast. Earlier this week, we also raised our S&P 500 EPS forecasts to $187 for 2021 and $200 for 2022, up from $177 and $193 respectively.
- Our new EPS forecasts bake in better margins and buyback assumptions than our previous forecast, along with a moderate, roughly 4%, increase in the effective tax rate for the S&P 500 in 2022. We expect that the Biden White House will be successful in securing a compromise increase in the corporate tax rate that takes effect next year, and we’ve modeled in an increase from 21% to 25%.
- If we didn’t bake in a corporate tax hike, our number for 2022 would be $210, in line with the bottom up consensus of $209.
- In the last few weeks, investors keep asking me why analysts aren’t baking tax hikes into their forecasts – we think they have a good point and it’s caused us to understand that this is how a lot of investors are thinking about next year’s earnings. Even though the details surrounding a corporate tax hike are still up in the air, we think it’s appropriate to adjust our earnings numbers to reflect this overhang on the market.
Wrapping up with the overall signal that we intended to send with these moves: we see a little more room for stocks to climb higher this year, but we also continue to expect a pullback or heightened volatility in the market before the year is done capping that upside.
- Our forecasts have changed slightly, but our basic view of US equities in the back half of 2021 hasn’t changed that much at all.
- We continue to think 2021 will end up being a strong year in the US equity market – the 15% full year move we’re anticipating is actually the most common type of up year in the S&P 500.
- Pillars of support include a strong economic backdrop, high levels of corporate confidence, strong cash deployment trends, and ample monetary and fiscal stimulus.
- But we also continue to see a number of pressure points for the market, including euphoric investor sentiment/positioning, the peak in the growth rate of S&P 500 EPS that’s likely underway at the moment, which we discussed in last week’s podcast, the rotation out of Tech, and uncertainty over tax policy, which actually has a lot of public support. These are all headwinds and overhangs on the broader US equity market in the months ahead.
That’s all for now. Thanks for listening. And be sure to reach out to your RBC representative with any questions.