Welcome to RBC’s Markets in Motion podcast, recorded September 13, 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.
Today, we’re updating our thoughts on the broader US equity market outlook. Three big things you need to know: (1) First, we are making some adjustments to our existing S&P 500 forecasts, lifting our 2021 EPS forecast and price target by ~4%, and lifting our 2022 EPS forecast by ~3%, while also introducing our S&P 500 price target for 2022, which calls for a 9% annual gain. (2) Second, we continue to see risk of a pullback in the S&P 500 before year end, but view it as a buying opportunity. (3) Third, one key risk that we are monitoring for the stock market – and our call – is the possibility that S&P 500 EPS growth will turn negative in early 2022.
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Now, let’s jump into the details.
- Let’s start with our first takeaway, the updates to our S&P 500 forecasts.
- For 2021, our S&P 500 price target moves from 4,325 to 4,500, while our 2021 EPS forecast moves from $192 to $200. These are upward revisions of 4%.
- For 2022, we are introducing a price target of 4,900 or a 9% gain on the year, while moving our EPS forecast up just under 3% from $216 to $222.
- While we do not yet have a 2023 price target, we are introducing a preliminary 2023 EPS forecast of $238.
- Our revised year-end S&P 500 target of 4,500, which is essentially in line with the YTD or all time high, is in line with the best case among all of the back tests and scenario analysis that we’ve examined. It assumes the forward P/E, based on next year’s EPS, at year-end 2021 will be flat vs. year-end 2020 - at just over 20x - and takes into account the latest revisions to our EPS forecasts, which are updated for better than expected 2Q results and post Labor Day macro expectations.
- Our new 2022 price target of 4,900 is the median and average of 12 different economic, earnings, and valuation tests that we ran. They are mostly pointing to a solid year for the market but more moderate gains.
- Moving on to our second takeaway, while we’ve tweaked some of our numbers, we want to stress that our narrative on the market is largely unchanged - we continue to see risk of a pullback in the S&P 500 before year end, but are emphasizing that we view it as a buying opportunity if and when it happens.
- As our regular listeners are well aware, the late year pullback call is one that we’ve been making for the past several months due in part to elevated equity market sentiment and positioning. We see this in futures market positioning for asset managers,
- As well as in global tactical asset allocation funds where US equity stakes hit all time highs over the summer.
- Trends are similar for individual investors when we look at the composition of household balance sheets.
- Something else that’s kept us on guard for a pullback is the tendency of the S&P 500 to decline modestly on a 6 month forward basis after an early cycle peak in the rate of change in S&P 500 EPS growth occurs, which 2Q21 will be in the current cycle.
- But we expect a pullback in the 5-10% range, shy of an actual growth scare which tends to see stocks fall in the mid to high teens.
- We think some of the language that’s come out over the past week about a growth scare is a little too harsh for a few reasons.
- First, even with recent downgrades, consensus forecasts still expect the US economy to see growth rates well above trend in the year ahead – there’s plenty of room for some downward revisions without taking us to a bad place economically.
- Second, the high frequency indicators that revealed the negative impact the Delta variant was having in late July and early August such as Opentable dining, TSA flying, and Langer Consumer Comfort have started to turn up again.
- One exception is back to work, which remains under pressure according to Kastle data, but this may improve as Biden’s plan for expanding vaccinations takes effect, as an early September Morning Consult poll indicated that 65% would only consider returning to an office when all of their coworkers were vaccinated.
- Third, COVID trends are on the mend, with signs of a peak in cases nationally and in all major regions.
- On a related note, there are also some indications that back to school fears were improving even before Friday’s press reports that some health officials believe PFE’s vaccine could get approval for 5-11 year olds by the end of October.
- Wrapping up with our third takeaway – while we’re not worried about an economic recession, the big risk that we are monitoring for the stock market – and our call – is the possibility that S&P 500 EPS growth will turn negative in early 2022.
- Bottom up consensus estimates for S&P 500 EPS growth are tracking at 4-5% in 1H22.
- Investors have been worrying about margin impacts from supply chains and labor, and concerns about higher corporate taxes are back in the spotlight. There were even reports last week that Senate Democrats are looking at a buyback tax.
- All of these issues seem manageable in isolation, but collectively could be more of a drag on EPS than the market can tolerate.
- 2015-2016 may end up being a useful reference point if EPS growth flips negative in 1H22. Back then, the S&P 500 fell 14.2% peak to trough. But it was still a buying opportunity for longer-term investors as the index rose 9.5% for 2016 as a whole.
- We also suspect the decline in the index could be less severe this time around since secular growth oriented sectors accounts for 51% of the index’s weight (more than double the weight of Cyclicals), compared to just 35% (the same as Cyclicals) in mid-2015. When investors get nervous and pile into higher quality and secular growth, it actually benefits the S&P 500 as long as clear and present signs of economic recession are absent.
That’s all for now. Thanks for listening. And please reach out to your RBC representative with any questions.