Good news: nearly everyone is worried
And that's just another reason the setup for stocks remains strong.
A lot of clients, news commentators and even some of my smartest hedge-fund friends say they’re worried about this market. They fear it’s a bubble. But the thing about bubbles is they can last a long time, and that’s assuming this is a bubble. As we noted last month, we don’t believe the broad market, at least, is in a bubble at all. Sure, there are bubble stocks in speculative parts of the market, just as there were in the dot-com era. But much of the market remains undervalued in our view, supported by strong fundamentals, a widening vaccine rollout, a budding synchronized global recovery, reasonable equity valuations relative to low-yielding bonds, a seemingly unending flow of fiscal and monetary stimulus and, yes, even worries that help keep euphoria at bay.
As for those who have been insisting for a year now that “the market is detached from economic reality,” we’d say “reality” is in the eye of the beholder. In the rearview mirror, for sure, the “reality” looks pretty bad: an historic global pandemic that simultaneously shut down the entire global economy at the same time, an historic drop in global GDP and S&P 500 earnings, and an historic 35% crash of the stock market. But equity investors look forward, not backward, and at Federated Hermes, at least, we see the “reality” very much in sync with the market. A coming synchronized global recovery as the vaccine rolls out around the world and consumers everywhere come out of their caves and spend the record amount of cash they’ve amassed over the past year, with central banks and fiscal authorities, just for good measure, throwing yet more record stimulus fuel on what by late summer could be a raging forest fire. Earnings, and equities, will have nowhere to go but up, particularly if bond yields remain below 1.5%, our year-end target for the 10-year Treasury.
For the broad market average, the S&P 500, our 4,500 year-end target remains unchanged, with leaders likely to come from last year’s laggards—cyclical value, energy and emerging-market stocks that typically do best in the early stages of economic expansion. We added to these areas in January in our stock-bond model and again this month on the “Value” pullback that ushered in the new year. We stand poised to add further on any additional dips. We’re in no way abandoning technology stocks; we like many of them, too. Last year’s stars experienced dramatic demand as the pandemic’s stay-at-home world accelerated changes in the way our economy operates—a digital transformation that in many ways is still in its early stages. Abetted by this transition, and by a surge in pent-up demand as consumers emerge from their Covid caves, we expect this year’s economy to fully recover soon from last year’s steep but short recession.
Best year for GDP growth 37 years?
We think real GDP could grow in 2021 by as much as 6%, which would be its fastest pace since 1984. While jobless claims are still high, it appears they are in the early stages of an extended downtrend—one that we think will occur more quickly than economists expect as the gig economy turns fully back on and hard-hit restaurants, hotels and other hospitality industries experience summertime revivals in business. Households certainly have the cash, with savings running at 45-year highs, hourly earnings climbing at a 4-5% year-over-year (y/y) pace and more stimulus checks on the way. We saw what those checks can do with January’s retail sales blowout. A new housing boom cycle is upon us, important for both jobs and the consumer wealth affect, and manufacturing—as evidenced by regional Fed data this week—is soaring, the only headwind being the struggle of commodities markets, from computer chips to oil to copper, to keep up with demand after years of investment cutbacks.
Earnings and valuations supportive
All of this is supportive for earnings, which are closing a much better-than-expected reporting season. Fourth-quarter beats and guidance were strong across almost all sectors as lockdown and broader tech/cloud plays continued strong, diversified manufacturers surprised and financials led all sectors with 21% y/y earnings growth. Overall, 80% of companies beat and earnings were up more than 3% y/y versus initial y/y consensus of a 9% down quarter. This suggests estimates for this year are too low and likely will continue to rise, with an extra shove potentially coming from commodities. From agriculture to oil, the forward commodities cycle looks powerful to us, with the combination of recent underinvestment and a global recovery likely to cause shortages and already rising prices to spike. We think West Texas Intermediate crude, which you may recall briefly went negative last April amid a collapse in demand and flood of stored supply in tankers, could close the year at $90. By our numbers, the S&P is trading at 19 times 2022 earnings, elevated but not all that high compared to Treasury yields.
When does this constructive environment for stocks end? My guess that’s a ways out, for two reasons. First, bulls this strong and healthy don’t normally die until a true, broad market bubble develops. Both the Nikkei Bubble in the late 1980s and the Nasdaq Bubble a decade later ended with broad market P/E multiples in the high 20s, considerably above present levels, and with earnings decelerating, not accelerating. This point usually comes once the last bear has been fired or given up, and no one is worried. Hardly the case today! The second ingredient, historically, for a broad bubble collapse is a sudden change in direction by the central bank. Japan’s bubble peaked only a few months after the Bank of Japan’s first rate hike in May 1989, and the Nasdaq Bubble burst shortly after the Fed’s post Y2K-hike in February 2000. So, at Federated Hermes at least, we’re watching the Fed carefully for signs it’s about to blink. Based on all the evidence, this seems unlikely till a good distance into the future. But we’ll see.
So, for all my bearish friends out there—call me when you’re converted to the bull. That’s when I will start worrying.