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Why This Strategist Sees an 8% S&P 500 Upside

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Consistent with the nature of this price target raise is the idea that most on Wall Street expect the S&P 500 to end 2020 higher than where it is right now. The reason: excluding extensive new lockdowns, 2021 earnings per share growth, paired with the slight negative of rising interest rates, should carry the index up from here. 

Canaccord Genuity’s Chief Market Strategist Tony Dwyer raised his price target on the S&P 500 up to 3,300, representing about 8% upside from its level Monday June 29. Dwyer does think “the market is likely to remain in a period of consolidation marked by increased volatility as it digests the historic gains off the COVID-19 low…and works through a historic shutdown and reopening, he wrote in a note. 

Last week, the S&P 500 fell almost 3% as 12 states are now halting reopening plans on the back of surging virus cases, a development that could cut short the extremely positive economic trends recently seen in employment and retail sales figures. Valuations have come in slightly while forward one-year earnings estimates have come off of their 2020 bottoms, so there could be less investor interest in adding to stocks for the near-term. 

Investors know the Federal Reserve is pumping liquidity into all areas of the bond market. They’re now looking for fiscal stimulus -- potentially another $1,000 per household cash injection -- to provide yet another bridge to yet another reopening, should the virus case surge remain ugly. 

“The combination of incredible monetary stimulus that is likely to continue for the foreseeable future and the subsequent credit market and liquidity improvement allows us to move out 2021 SPX operating EPS to $165/share in 2021,” Dwyer said, which is up from $150. Using a 20 times multiple on that estimate brings him to his year-end target of 3,300. Currently, the S&P 500 trades at just above 21 times earnings, which compared to the 10-Year Treasury yield at the historically low 0.64%, isn’t overvalued if one assumes an economic recovery. But Dwyer, like other bulls on Wall Street sees the current economic recovery as sustainable -- excluding more virus-induced lockdowns -- and driving interest rates a bit higher. Some look for the 10-year yield to hit roughly 1%, which would cause earnings multiples to come down a bit. 

“We expect valuations to come down by 10% as next-twelve-months EPS [estimates] rises by close to 20% over the next year, leaving 10% upside for the S&P 500,” wrote Morgan Stanley’s chief U.S. Equity Strategist Mike Wilson in a note. 

So given the earnings projections, how about that economic recovery? 

Dwyer sees liquidity continuing to flow through, as credit spreads have fallen to 6% (high yields minus the safe 10-year treasury yield) from 11% at the peak market fear level this year. Historically, those spreads sit closer to 5% or 4%, but Citizens Financial’s Head of Corporate Finance and Capital Markets recently told TheStreet that the absolute low level of interest rates is enabling large corporations to borrow and shore up liquidity for an extended period, should the U.S. lock down again. Investment grade bond yields now offer just over 1% more than the 10-year does, in line with history. This is another enabler to corporate borrowing. 

Other economic data like GDP, employment and measures of financial conditions are pointing to more economic momentum. 

Dwyer’s call for EPS growth of 32% year-over-year in 2021 brings EPS back to its 2019 level, but S&P 500’s high of 3,393 in late February was pricing in forward EPS of just under $180. Still, this type of bounce in stocks by year-end would indicate a market back on a path to its normal level. 

Those more bearish on stocks do point out that record high unemployment is unlikely to be reversed fast enough to support current 2021 EPS estimates, although much of the debate rests on the extent to which stimulus can boost the economy. 

One other big risk: the presidential election and corporate taxes. 

The point: the stock market may be positioned nicely through year-end, but much of that move is highly dependent on health outcomes, which Wall Street isn’t trained to assess. 

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