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Jeff Agne, I’m a managing director at Rothschild Asset Management and a co-portfolio manager of the large-cap value products.
Regarding how much upside we see left in stocks, we’ll point out that 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.
So, to help put valuation into context, the stock market, as measured by the S&P 500, is trading at about 20 times 2022 consensus EPS estimates, which is a premium to the historical average. Of course, elevated valuations are at least in part supported by the unprecedented fiscal and monetary stimulus, and an economy that should experience above-trend GDP growth as we come out of this pandemic.
And just for some historical context, the S&P 500’s forward multiple reached 24 times just before the dot-com bubble burst about two decades ago — though we would note there are many differences between the environment today and during that time period.
And so maybe to answer the question more directly, we’re optimistic about corporate profits, which are ultimately a big driver of stock returns. We think we’ll continue to see upward revisions to 2021 and 2022 corporate profit estimates, and believe the market can continue to move higher. Although a lot of good news does now look discounted in stocks, which would argue for some contraction in valuation multiples as the cycle progresses.
So, in terms of where we think we are in the cycle, I mentioned stocks have had a huge move over the last year, and over the last six months or so we’ve seen the so-called reopening trade play out. So, airlines, restaurants, hotels, retailers — all the areas of the economy levered to consumer spending that Covid shut down — have rallied back hard. But the consumer remains flush with cash, and people are ready to go out and spend.
So, with that said, we think that leaves us somewhere in the middle innings of the cycle. We think and we hope that the worst of this pandemic is behind us. We’ve seen more than half of the U.S. population get vaccinated, and Covid cases and deaths continue to drop.
GDP growth should be very strong in 2021 and into 2022, and additional positive estimate revision, should we get them — and we think we will — will support the market at current levels and could lead to further upside.
One thing to keep an eye on is inventory levels. 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. That’s one of the reasons we think we’re moving into the middle innings of the cycle.
But make no mistake, 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. And for all those reasons, we remain constructive on the market.
So, where’s inflation headed, and how worried are we about it? It’s a very topical question. It seems like every time I read the newspaper, I see more and more evidence of inflation in the system, and there’s no question that all the liquidity in the system is inflating asset prices in many end markets.
We see it in the housing market with inputs like lumber. We see it in metal and food commodity prices, in our fuel prices, the new and used car market, furniture, etc. And so far, most of that inflation is being passed through. So, rising lumber prices are flowing through to higher home prices to the home buyer, for example.
So, it’s something we’re really focused on. And I think the question really comes down to whether or not the inflation we’re seeing is transitory, or whether it could last longer, and whether or not the reopening of the economy could actually ease inflation as the consumer is able to go out and spend their money in additional parts of the economy, like in travel and leisure experiences.
Could rising inflation force the Fed to have to taper sooner than expected? You know, it certainly could, and that’s perhaps the biggest tail risk we see right now. If we see evidence that inflation is running hotter than expected, it could force the Fed to taper sooner than the timeline they’ve given.
Right now, consensus is for the Fed to begin to taper sometime in late 2021 or early 2022. And if the perception in the market is that the Fed is acting sooner because they are behind the curve, we don’t think the market will react well to that.
But on the other hand, if the Fed starts to taper because the underlying economic growth is strong, with strong underlying demand in the economy, we think the market could handle that, especially given that rates are near historic lows.
And lastly, we think the Fed is willing to allow inflation to run a little above their normal 2% target for some time before they’ll feel the need to act.