With Our 3500 S&P 500 Target Ahead of Plan…What To Do Now?
“The most important quality for an investor is temperament not intellect.”
Back in February/March of this year when COVID-19 angst was at its peak, so was fear in the stock market. The VIX, or so-called fear gauge for stocks, was spiking and stock prices were plummeting…in the United States and globally1. In a matter of just 33 days, the S&P 500 fell over 30%. It was boldly pronounced in most media venues that we were definitively in a bear market that had legs2. Many experts were suggesting significant downside was ahead of us as coronavirus cases quickly spread on U.S. shores, particularly in the New York area, on the heels of scary levels of mass contagion in Europe.
“This time is different” was a common phrase—about as often-quoted as the word “unprecedented” to describe the state of the state. Unlike many other panic attacks that had challenged the markets during the bull run that began in 2009, investors embraced the idea that this swoon would take multiple quarters and years, perhaps, from which to recover. Our take at the market lows of 2235 in the S&P 500 in the spring was a bit different. While we agreed that the type of risk in the world could be characterized as “unprecedented,” the level of risk was not. In our research, we believed we’ve seen similar levels of risk in previous periods of challenge from which the market recovered in due course through prudent fiscal and monetary policy responses and flexibility in our economy.
The rapid and sharp recovery in 2019 (S&P 500 advanced over 31% in 2019) from the faux recession telegraphed via the 20%-plus downdraft in the market in the month of December 2018, serves as the latest example of uber negativity, prior to coronavirus, that proved unwarranted. Earlier this year, S&P 500 targets of 1800 and below were trumpeted at the March trough in the headlines. Yes, we respected risk in the near term at that point and had a cautious short term outlook due to unknowns about how broadly COVID-19 might spread in the United States and the negative economic impact it might inspire, but we believed this was a transitory issue and that policy responses would be significant and effective.
We also appreciated that this was a forced economic shutdown to invest in our health, versus a normal business cycle train wreck that usually precedes previous true extended bear market periods. Far better to go into a period of uncertainty and forced shutdown with solid economic momentum than with a flagging economy. The coronavirus chapter was more like the risks and human anguish that emanate around a natural disaster such as earthquake or hurricane, as we viewed the landscape…devastating in scope for a temporary period, but something that also creates pent-up demand and can result in strong recovery via the will and energy to reopen and rebuild. Our message is what we had/have in this case.
As a result, we have adopted a contrarian message and have maintained a 3500 target on the S&P 500 by mid-2021 and throughout. While bold at the time back in March, now that 3500 price target we established by the mid-part of next year seems rather conservative. At the end of August, we are there! In fact, as the chart below shows, this was the swiftest 100-day rally to a new high in the S&P 500 off of a 30% plus decline in the market in history.3
We were, though, surprised at the speed at which the market has recovered. We have no regrets as our mantra was, “Hold Your Ground and Upgrade Holdings” during this difficult and volatile period. We were neither net sellers or net buyers of stocks in the aggregate; rather we believed that maintaining asset allocation and existing stock exposure was the correct course of action. Selling, we thought, around the peak in fear at the March trough would open one up to too great a risk of whiplash, given the fundamental backdrop and facts, and that the risk of selling would have a high probability of missing out on meaningful market recovery by mid-2021. Buying aggressively and increasing stock exposure, on the other hand, would have ignored the uncertainty and downside risks that the pandemic would be untamed and cause more than temporary economic damage…this latter scenario being unlikely in our view but not out of the question.
We are pleased with the outcome of our “hold your ground” posture when many thought the sky was falling. And, per the quote above from Warren Buffet, for an investor with significant intellect, it was the mixed but positively-tilted nature of the data and the facts that provided us with the temperament to hold our allocation and exposure in the midst of a short but meaningful decline and supported our efforts to do the same (versus trim on strength) during the surprisingly swift rally…rather than getting pushed around and confused by the roller coaster of emotions floating about.
No doubt, now that we have reached new highs in the market and stand right around our 3500 target that we expected to achieve by June 30 of next year, folks are wondering what we are thinking and doing. Are we suggesting trimming on strength? Are we increasing our target? Do we suffer from fear of missing out and want to get more aggressive in buying and in our stock allocation? The answer is, none of the above. We maintain our “hold your ground” recommendation. While the economic and earnings data is mixed, it definitely skews to the positive. So there is enough constructive information to keep us recommending stock allocations be kept at current levels and not engage in any urge to take profits or trim back in stock holdings at a broad level. Client situations, of course, could trump this general strategy posture. But, in general, we have no change in asset allocation positioning after this rally.
In regard to taking up our 3500 target, we are biased to do so but would like to get through the peak levels of risk on some near term, wall of worry items such as the final months of the presidential election campaign and psychology surrounding various election outcomes, as well as concern over a fall surge in COVID-19 as schools continue to reopen. It is feared in the media that this could cause a pause in recovery and perhaps a double-dip recession.
In terms of current activity in the economy, the trend looks quite good and a double dip does not appear in sight…in fact, the pure economic data at present supports our bias to increase our 3500 target. There is a plethora of positively trending data. Specifically, the Atlanta Federal Reserve and prestigious private economic forecasters are increasing Q3 gross domestic product (GDP) projected growth rates to north of 25% after the implosion in the economy in Q2.4 Housing, auto activity and retail sales are surprisingly strong. Retail sales and personal disposable income are above pre-coronavirus levels and consumer mobility metrics are rising sharply as people are on the move and active in work and recreational activities more and more after a period of severe shutdown. See the chart on this below.
In addition, credit spreads remain tight and rates are low, yet the yield curve is steepening. Leadership in equities is decidedly in the more cyclical and aggressive areas of the market as opposed to the defensives. Industrial and consumer discretionary stocks, rather than utilities and other bond-like stocks, are showing the most momentum at present. These are all signs that the trend in the market should take us higher. That said, our caution comes from the facts that investors are very concerned about the election near term, and we have yet to see a new stimulus bill that will be necessary to maintain support for consumer spending as we move into the final months of the year without a major breakthrough in vaccines or COVID-19 treatment.
Without getting too quantitative on you, there are only three ways to take price target up.
- Believe that P/E’s will expand from here
- Increase earnings per share expectations
- Anticipate that interest rates will remain low or move lower
On these points, there is little room for P/E expansion from here; the catalyst for such an event would be definitive news of a proven vaccine or remedy. We do look for EPS expectations to rise but in measured fashion and this will take some time. We do expect rates to remain relatively low, but positive news on the above two points could drive them higher. Our summary on this is that we would expect the market to trade in a range for a bit and perhaps to see the market pull back a tad before these three drivers come together in concert to increase our target for the year-end 2021 period. The facts are positive enough that we believe we will do this in a reasonable period of time in the future, but we are being measured and exercising patience on this front.
The Wild Card Wall of Worry Items—Election Outcome and Risks of Double Dip
Both of these wall of worry items should serve as an anchor on psychology and cause volatility to increase or even act as the catalyst for a 5-15% market correction, but neither should derail the 12-15 month upside and positive advance we see in the S&P 500.
On the election front, the battle has narrowed. While only several weeks ago, it appeared as though Biden had a commanding lead in polls and the betting odds, that is no longer the case. Odds of a Democratic sweep have also declined a bit. While a Democratic sweep could cause investors to fear that such an outcome would automatically result in tax increases, and thus declining EPS, we think these fears are overdone. Biden and a Democratic congress are unlikely to pass tax increases immediately if the economy is fragile as a first point. More importantly, while Biden has publicly stated he would increase corporate and personal tax rates, such EPS dilution from these initiatives would largely be offset from stimulative policies he favors, such as infrastructure spending, programs for the middle class and softer tariffs. So, we think the feared negative economic impact of a Democratic sweep is perhaps overdone. And to confirm, none of the above are political comments, they are just thoughts on economic impact of regime change. We do think there is risk of a contested election if the race is tight; that said, when this happened back in the Bush/Gore days in 2000, the market sold off about 5% until things were resolved…so a contested election experience presents transitory and modest risk in our view.
In regard to a double-dip recession, leading economic indicators and the body of economic data highlighted above suggest this is just not a front-and-center concern at this point. A softening in the data, not an implosion in the data, is the more likely risk, which, in our view, would cause the market to pause for a bit but not act to ignite a bear market.
Based on the facts and the types but still manageable nature of current wall of worry items, we believe a “hold your ground” posture is still the prudent strategy and that temperament is key in this still challenging environment. We remain cautious near term but positive long term.
1FactSet, 12m VIX price
2FactSet, S&P 500 2/18/2020 – 3/24/2020
3Strategas, Technical Strategy 8/12/2020, S&P Forward Performance Chart
4Atlanta Federal Reserve: GDP Now
5Strategas: Weekend Reader, 8/29/2020, U.S. Mobility Index Chart
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