Equities investors have benefited from impressive one-year returns since the market lows of the pandemic, though some sectors fared better than others. With solid returns behind them and economic uncertainty ahead of them, investors are considering where equities go from here.
“The market has rallied more than 20% since the vaccine news in early November — and that’s on top of a huge move off of the April 2020 lows,” said Jeff Agne, managing director at New York–based Rothschild Asset Management and co-portfolio manager of the firm’s large-cap value products.
Agne also noted high valuations, with the S&P 500 trading at about 20 times the 2022 consensus earnings-per-share estimates — a premium to the historical average.
Just before the dot-com bubble burst more than two decades ago, the S&P 500’s forward multiple reached 24 times, he said, though the two periods have many differences and can’t be directly compared.
Despite being elevated, however, today’s valuations are supported at least in part by massive fiscal and monetary stimulus, said Agne, whose firm manages the Renaissance U.S. Equity Value Fund. Further, the economy should make good on above-trend growth during the post-pandemic recovery.
In April, the IMF updated its economic growth projections, with U.S. growth estimated at 6.4% this year and Canadian growth at 5%.
Agnes said he expects continued upward revisions to U.S. GDP, which will “support the market at current levels and could lead to further upside.”
Likewise, he expects to see continued upward revisions to 2021 and 2022 corporate profit estimates, moving the market higher.
“We’re optimistic about corporate profits, which are ultimately a big driver of stock returns,” Agne said. At the same time, he added, “a lot of good news does now look discounted in stocks, which would argue for some contraction in valuation multiples as the cycle progresses.”
The market cycle is currently in its middle innings, Agne estimated. The reopening trade — airlines, restaurants, hotels, retailers — has “rallied back hard” over the last six months, and consumers remain flush with cash. “People are ready to go out and spend,” he said.
Consumer demand can’t be fully satisfied in some areas because of shortages, from steel to semiconductors. “Covid depleted a lot of the inventory and various supply chains around the world, and it’s going to take some time for that to normalize,” Agne said. “That’s one of the reasons we think we’re moving into the middle innings of the cycle.”
Prices are rising, however, and the biggest tail risk for the market is the potential for inflation to force the Fed to taper its asset purchases sooner than expected, Agne said. Consensus is for the Fed to taper late this year or in early 2022. Fed officials are meeting this week, with a rate decision and updated forecasts coming Wednesday.
If the Fed were to taper earlier and be perceived to be behind the curve in doing so, “we don’t think the market will react well to that, especially given that rates are near historic lows,” Agne said.
In the U.S., prices increased 0.6% in May and 5% in the last year — the biggest 12-month jump since 2008.
“Equity markets weren’t exactly fussed by the hotter-than-expected [inflation] gains,” wrote BMO economist Carl Campus in a weekly equities report. Market performance last week reflected central banks’ mantra that inflation will be transitory, he said.
As things stand, Agne said he remains constructive on equities. “Economic momentum keeps building, GDP growth is accelerating, credit growth remains very healthy, profit margins are near all-time highs and the Fed remains accommodative,” he said.
Over the longer term, the threat of higher inflation and a less accommodative environment makes the case for a barbell approach to investing, said Kevin McCreadie, CEO and CIO at AGF Management Ltd., in a recent blogpost.
That approach “emphasizes quality stocks but also doesn’t overly discriminate between growth or value or some other theme at the expense of proper diversification,” McCreadie said.
“Investors need to be careful about chasing returns that have already been realized instead of trying to earn what comes next through a careful analysis of current valuations and the fundamentals of individual companies.”
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