Amidst growing concerns of a stock market pullback of sorts, one of Wall Street’s top market strategists introduced an S&P 500 price target that prices in a 2021 recovery but that also reflects weak gains through the end of the year.
Canaccord Genuity Chief Market Strategist Tony Dwyer moved his price target on the S&P 500 to 3,000 by year-end, representing 2.3% upside from current levels. Furthermore, for the index to reach that level more than 7 months from the time of writing, it seems likely stocks will pull back before they move higher.
The S&P 500, having fallen 34% from its all-time high in February, has risen 31% since its bear market low on March 23. That leaves the index just 13% below the all-time high. This signifies investors see an economic recovery almost as sharp as the decline into recession.
The Federal Reserve has unleashed trillions of dollars of stimulus in multiple forms and Congress has appropriated trillions more for the same purpose. And there have been some positive signs from companies who say on their earnings reports that consumers are exhibiting a less severe decline in spending in April than they did in March. Digitally focused companies are thriving the most.
But many worry about state reopenings causing a second wave of coronavirus infections or that consumers will be too traumatized for some time to step outside at the same levels they did pre-virus. There isn’t a great deal of discourse on earnings multiples, which expand when interest rates fall. But the question currently, as the market prices in 2021 earnings, is where those estimates should stand.
The index trades at just over 17 times 2021 expected earnings per share of $166, which represents a growth rate of 29% over 2020 expectations. With the federal funds rate near 0% and the 10-year treasury bond yielding 0.72%, that multiple isn’t necessarily crazy.
But Dwyer questions the viability of 2021 estimates.
Dwyer sees 2021 EPS on the S&P 500 coming in at $150 and he thinks stocks will be trading at 20 times next 12 month’s EPS by year-end. That brings him to his price target.
But here’s what’s inside those assumptions.
"We are in uncharted territory relative to understanding the impact of shutting down a levered economy and believe until there is a vaccine, any reopening could be subpar, so we are using a 20% growth rate on our 2020 estimate that translates to $150 per share,” Dwyer wrote in his note. As for his multiple, he says when core personal expenditures (a measure of inflation) runs at between 1% and 3%, "We are taking a slightly higher multiple assumption of 20x to reflect a Fed that has largely backstopped risk in a very low inflation environment.”
Furthermore, Dwyer notes that market messaging is mixed. While some cyclical sectors have certainly participated in the rally, not all have. For instance, the S&P 500 Consumer Discretionary Index is up 34% since March 23, while the Invesco Banking ETF KBWB is up just 23%, even though lower rates mean higher loan volumes. Dwyer mentioned the financial sector was a meaningful part of the bounce off of the low in 2008, but the Invesco Banking ETF is down a tick since April. Importantly, the Consumer Discretionary index is indeed up 11% since April 9, while the S&P 500 is up 5.3%.
There’s also no doubt that the FAANG stocks plus Microsoft (MSFT) - Get Microsoft Corporation Report are up hugely since April 9. Amazon (AMZN) - Get Amazon.com Inc. Report, for instance, is up 18% since April 9. Investors tend to pile into big tech during economic uncertainty because these companies can largely remain growing through a recession, partly resulting from their respective secular growth industry trends.
Lastly, the 10-year treasury bond is yielding less compared to inflation than it was before April, signaling lower expectations for inflation and economic growth. Contrarily, the spread between the 10 year and 2-year is now greater than it was in the past few weeks, a bullish signal.
Case in point: the market is sending mixed signals, but stocks may be a bit ahead of themselves for the moment.