2021 2nd Quarter Equity Market Update

PUBLISHED BY RAYMOND JAMES & ASSOCIATES

Michael Gibbs, Director of Equity Portfolio & Technical Strategy

Joey Madere, CFA

Richard Sewell, CFA

For the full 2nd Quarter Equity Market Update- Click Here

Rapid vaccinations (>2/3rds of US adults have received at least one dose) have spurred a sharp reduction in daily COVID case counts and hospitalizations since the start of the year. This has resulted in a swift economic reopening which, boosted by enormous amounts of stimulus, is likely to push 2021 economic growth to its fastest pace in almost 40 years. And this economic momentum remains with manufacturing and services surveys continuing to advance at very strong levels. In fact, the sharp rate of recovery is creating inflation concerns for investors as supply has been unable to meet this heightened demand. This dramatic demand vs. supply imbalance could last for months, but we believe should abate over time as stimulus ebbs and supply chains reopen. Productivity growth (due to economic digitization) should also help offset inflationary pressures. Importantly, the Fed is expected to remain accommodative as the labor market recovery still has a way to go, and raising rates will come because the economy is strong.

The most important influence for equities over the long term is earnings, and earnings growth remains strong. Q1 earnings season posted one of the strongest upside surprises in history with S&P 500 earnings growth finishing up 49% y/y (more than double the 21.6% consensus expectation). This is leading to markedly higher earnings revisions for 2021 and 2022, with upside to estimates remaining in our view. In fact, we believe S&P 500 earnings will hit $200 in 2021 (+45% growth y/y). As earnings continue to recover, elevated valuation multiples should normalize in the back half of the year. In fact, the S&P 500 currently trades at a 25x P/E multiple (down from a 28x peak) which we believe will move directionally toward pre-pandemic levels (~22x) by year-end. The upshot is our belief the normalization in valuation will outweigh robust earnings growth, providing further upside to equities- $200 earnings estimate and 22x P/E assumption results in a base case S&P 500 target of 4400 by year-end.

While equity market performance has been historically strong over the past year, it is normal for year two of a bull market to moderate its rate of ascent. Inflation, Fed communication, and the debate over stimulus/taxes are likely to gain significance in the back half of this year. These items (among many others) can lead to short term volatility, something that has generally eluded equities in a broad sense since positive vaccine news in early November. The largest drawdown for the S&P 500 since then has been ~5%, while it is very normal (and healthy) historically to have 8-12% pullbacks in a bull market recovery throughout a year. We view the fundamental and technical backdrop as supportive over the intermediate term, and continue to see the positives as outweighing the potential negatives. Thus, we recommend using potential weakness as a buying opportunity. As has been the case for months now, volatility is likely to be seen more significantly beneath the surface as sector rotation continues to play out- leaving plenty of opportunity for active investors with our bias towards pro-cyclical sectors, Value over Growth with new funds, and U.S. equities exposure over Emerging Markets.