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You know what they say, “no pain, no gain”. I’m not sure 2020 could be better summarized for equity market investors. After all, the price you pay for potential gains is more volatility i.e. emotional pain. After an 18%+ return in the S&P 500 in 2020, I believe it’s time for stocks to take a pause. While many reasons exist, one simple reason is stocks are expensive. The current forward Price-to-Earnings (P/E) Ratio of the S&P 500 sits at 22x+ (as of 1/25/21). When you compare this to the 25 year historical average of 16.59x, it would not be a surprise if bumps and sideways movement characterized the first half of 2020. 1
So how could valuations get this lofty during a global pandemic? One word, potential. Wall Street is looking at the potential of the global economy given strong consumer demand, accommodative fiscal and monetary policy globally, and the hope of a “return to normal” as vaccines are administered. Now we wait. Will earnings continue to rebound and support the valuations Wall Street is expecting? We’ll see.
When suitable for our investors, our approach to 2021 is threefold:
- Reduce our overweight to Growth Stocks
- Maintain approximately 30% equity weighting to International stocks with an overweight to emerging markets
- Tactically overweight cyclical sectors and small companies that we think we benefit from more stimulus and a reopening economy
We believe these trades will serve our clients well, but we’ll have to remain patient if they are to realize their potential.
1Source: JPM Guide to the Markets – U.S. Data are as of January 25, 2021
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“In the short-term, the market is a popularity contest. In the long-term, the market is a weighing machine.” Warren Buffett
2021 is under way, as our nation and the rest of the world look to begin to put the global pandemic behind us. The path forward for the US economy, as well as that of the global economy, will continue to depend heavily on the success of combatting the virus.
While many of the risks presented by the outbreak of COVID-19 persist, it appears we may be in the later innings of the pandemic. Following increased restrictions to quell the holiday surge, new daily COVID-19 cases and hospitalizations have peaked, and are down significantly the past few weeks (source: COVID Tracking Project). Reopening is taking place as well, highlighted by New York City’s plans to bring back indoor dining by Valentine’s Day. Meanwhile, the distribution of currently approved vaccines is well underway—and accelerating. The United States has added over 1 million shots per day over the past week (source: CDC) and 1.5 million per day is quite possible soon. Adding to this optimistic trend, new vaccine candidates from Johnson & Johnson and Novavax have also shown efficacy in combatting the effects of the virus and new mutations. If these two candidates are authorized for use as most experts expect, the boost in supply will be a welcome development in the US and abroad.
Despite the positive trends in COVID-19 data, volatility began to return to the stock market in the final days of January, as retail traders set their eyes on GameStop (GME) stock and other heavily shorted securities, captivating the nation’s imagination. As Warren Buffett explained above, while many of these securities may be popular now, the real winners will likely be investors with longer-term horizons. While these developments could be another sign of excessive optimism in certain segments of the equity markets, we do not believe they represent a sign of a broader market bubble or indicate a major correction is forthcoming.
After the powerful snapback of economic growth seen in the third quarter, the economy continued to grow at a solid 4% in the fourth quarter despite the holiday surge in COVID-19 cases. This improving economic backdrop has provided tailwinds to corporate profits, which should help stocks grow into their elevated valuations. S&P 500 Index earnings for the fourth quarter are impressively tracking 9 percentage points ahead of consensus expectations, while more than 80% of companies have beaten earnings estimates (source: FactSet). Meanwhile, housing remains extremely strong nationally and manufacturing data continues to show an economy that is firmly on the mend.
The improving economic backdrop, along with US government and Federal Reserve policies designed to boost the economy, suggest the environment for risk assets may remain favorable in 2021.
This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risks including possible loss of principal. Any economic forecasts set forth may not develop as predicted and are subject to change.
References to markets, asset classes, and sectors are generally regarding the corresponding market index. Indexes are unmanaged statistical composites and cannot be invested into directly. Index performance is not indicative of the performance of any investment and do not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results.
Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services. LPL Financial doesn’t provide research on individual equities.
All index data from FactSet.
This Research material was prepared by LPL Financial, LLC. All information is believed to be from reliable sources; however LPL Financial makes no representation as to its completeness or accuracy.