January 8, 2021

Review the latest Weekly Headings by CIO Larry Adam.

Key Takeaways

• Expectations for a ‘powerful’ earnings rebound in 2021
• First year of the bull market is historically an ‘easy lift’
• Pre-recession GDP levels may ‘weigh on’ equity returns

We notched a 9.0 in 2019, an 8.5 in 2020, and now we’re hoping to score a perfect 10 as we present our Ten Themes for 2021 this Monday, January 11 at 4:15 PM. Our Ten Themes presentation is a collection of what we deem to be the most critical economic and financial market insights for investors in the upcoming year, and we’ve selected the Olympic Games as the perfect backdrop for our explanation of these topics. The quintessential athletic events are a fitting metaphor for the current times, as the games were cancelled in the midst of the pandemic last summer and are now rescheduled to begin on a date (July 23) that we hope coincides with the sustainable reopening of many parts of the world. As we utilize the Summer Games as the framework for our Ten Themes, each theme will be tied to an Olympic sport. As a preview of what is to come, we’ll use the sport of weightlifting to articulate our view for the equity market this year. 

• Investors Throw Their Weight Behind High Return Expectations | Equity market momentum has carried into 2021, with the S&P 500, Dow Jones Industrial Average, NASDAQ, and Russell 2000 all setting record highs this week. The S&P 500 has now rallied 20.6% over the last six months—a return that ranks in the 96th percentile over the last 30 years. Between our expectation for improving, sustainable economic activity, additional fiscal policy now that the Democratic Party has gained control of the Senate, and still accommodative policy from the Federal Reserve (Fed), we believe the S&P 500 is capable of reaching 4,025 by year end, representing a 5.7% price return from current levels). However, investors need to dial back heightened return expectations as we do not anticipate 2021 to repeat the returns experienced in 2019 (31.5%) and 2020 (18.4%) for several reasons:
  • Earnings Will Do The Heavy Lifting | The rise in the P/E multiple from 2019 through 2020 was the largest two-year contiguous expansion since at least 2000, increasing ~55% over this time period. While we remain positive on equities over the next 12 months, further P/E expansion is unlikely given our expectations for a modest rise in interest rates, a slight uptick in inflation, and the potential for the Fed discussing tapering quantitative easing purchases by year end. As a result, a ‘powerful’ earnings rebound will be needed to ‘raise the bar’ for equities. Improving economic activity should ‘push’ S&P 500 earnings to $175 in 2021, representing a 27% increase over 2020 levels. While positive earnings growth should support higher equity prices in the year ahead, it is important to note that since 2000, annual EPS growth of 15%+ has led to the S&P 500 experiencing below average returns on a price return basis (6% versus 8.2% average).
  • First Year Of The Bull Market Is The Easiest Lift | The S&P 500 has rallied 72.4% since the start of the bull market on March 23, setting a ‘personal record’ as the best start to a bull market in the post-World War II era. While bull markets tend to last six years on average, the first year is historically the best before the equity market starts to ‘bend’ under the ‘weight’ it has been carrying. Since 1945, the first year of a bull market has appeared to be the ‘easy lift,’ rising ~40% on average. Moving forward, the ‘strength’ is tested, with the returns for the 2nd and 3rd years of a bull market slowing to 13.3% and 2.5% on average, respectively. With many positive factors already priced into the market, we suspect the current bull market could follow a similar trajectory.
  • Pre-Recession Economic Levels May Not Be The Best Platform | Since 1945, the US economy has needed ~18 months, on average, to recover economic losses during a recession. Despite the recent recession being the steepest since the Great Depression, we expect the economy to recover all of its losses and return to pre-recession GDP levels by the end of the second quarter or early third quarter—consistent with history. While the US economy recovers its losses and enters the expansionary phase of the business cycle, this feat has historically not led to above average forward returns for the equity market. In the 9 months leading up to the full recovery, the S&P 500 has rallied ~14% on average and been positive 90% of the time. However, 9 months after the full recovery (i.e., expansionary phase), the S&P 500 has only ‘muscled-out’ a ~3% return and has been positive only 55% of the time. If history repeats itself, the index may struggle to maintain its momentum in the latter half of the year.
  • Economic Data No Longer Lifting Off Weak Levels | Much of equity rally has been predicated on the expected strong recovery in economic activity. While the December jobs report was disappointing, with the US economy losing 140k jobs and ending the streak of monthly job gains that started in May, the ISM Manufacturing Index rose above 60 for the first time since August 2018, suggesting that the US manufacturing sector is on solid footing. However, this level has historically not been a strong tailwind for the equity market in the proceeding months. In fact, after rising above the 60 threshold, the S&P 500 has rallied only ~2% on average over the next 12-month period and been positive only 64% of the time.

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Video recorded November 13, 2020. All expressions of opinion reflect the judgment of Raymond James & Associates, Inc., and are subject to change. Information has been obtained from sources considered reliable, but we do not guarantee that the material presented is accurate or that it provides a complete description of the securities, markets or developments mentioned. There is no assurance any of the trends mentioned will continue or that any of the forecasts mentioned will occur. Economic and market conditions are subject to change. Investing involves risk including the possible loss of capital. International investing involves additional risks such as currency fluctuations, differing financial accounting standards, and possible political and economic instability. These risks are greater in emerging markets. Companies engaged in business related to a specific sector are subject to fierce competition and their products and services may be subject to rapid obsolescence. Past performance may not be indicative of future results.