The September update to the Market Multiple Table revealed two important realities. First, we should expect Washington to become an influence on markets between now and year-end. Second, at these valuations this market remains largely priced to perfection (which doesn’t mean stocks can’t rally further, but it does mean it’s a long way down to support if something goes seriously wrong).
Starting with the change to the Market Multiple Table this month, we added “Tax Hikes” as a market influence because we expect “Tax Hike” headlines to increase over the coming weeks and to increase market volatility (there was a WSJ article out yesterday about potential corporate tax increases and we think this is the start of a trend).
Meanwhile, when we look at the market ranges for the scenarios, it remains clear that at these levels the S&P 500 is priced for relative perfection, and to realistically expect the S&P 500 to grind higher from here, we’ll either need to see 1) 2022 expected earnings increase from the current “best case” of $225/share, or 2) See more fiscal stimulus but no new tax hikes (which amounts to additional fuel on the economic fire). Point being, while the market remains fundamentally well supported and the rally remains intact, the scenarios where we see materially higher prices from here remain slim (although they are still possible).
Outside of those two issues the other current influences on stocks remained mostly unchanged, as a combination of Fed tapering, COVID trends and economic growth/stagflation risks remain the major influences on stocks, and their “Gets better if/Gets worse if” have changed slightly at the margin but remain mostly the same as before.
Current Situation.
The current situation improved slightly from the August Market Multiple Table, as Fed Chair Powell signaled tapering is coming, but strongly hinted it won’t come until the end of the year and the pace will be slow (no more than $15 billion/month and possibly less). COVID cases, meanwhile, appear to have peaked and the Delta variant surge came and (hopefully) went without any new lockdowns. Regarding the economy, yes, the Delta variant has resulted in a loss of momentum, but the recovery is still intact and as long as COVID cases decline, then any loss of momentum should be relatively temporary. And in this environment and at these levels, the S&P 500 is reflecting the expectation for this set up to continue, and for earnings to creep higher (which is why the S&P 500 is above the top end of the reasonable range for this environment). In fairness, pricing in better earnings has been the right play so far in 2021, but I’ll again stress that at these levels the market has priced in everything good and then some more, and that leaves it vulnerable to an air pocket.
Things Get Better If: The Fed Confirms Tapering Will Be More Gradual Than Expected (<$15 billion/month) and Confirms a December or January 2022 start, COVID cases peak and recede in the next few weeks, Growth stays solid while inflation recedes and the $1 trillion infrastructure bill passes but there are no tax hikes. This is essentially the “best case” scenario for stocks in that an even more gradual tapering timeline is confirmed, COVID is no longer an influence, we get a resumption of a virtuous economic reflation (strong growth/declining inflation) and Congress passes infrastructure spending but no tax hikes. This near perfect scenario would lift S&P 500 earnings expectations for 2022 to as high as $225 and the extra fiscal stimulus would justify a 21X multiple, putting a target for the S&P 500 into the upper 4000s.
Things Get Worse If: The Fed Implies Tapering Before December or > $15 billion/month, COVID Cases Rise and Cause Behavior Changes and/or Lockdowns, We See Growth Stall and Inflation Keep Rising (Stagflation) and/or Congress passes tax increases. Any one of these “negatives” could break the current bullish recipe for markets and cause a 10%ish pullback (easily). However, if two or more of these events occur, then we’re looking at the possibility of a 20% correction given 1) Stretched valuations and 2) Investor complacency (no 5% declines in nearly a year) and 3) Little fundamental support around current levels.
Bottom line, the MMT reflects the reality that the macro set up remains very positive. But at the same time, this is a market that, as things stand, doesn’t have a lot more upside unless we get substantial earning improvement or more stimulus from Washington. So, while the bullish recipe remains the most credible outcome near term, this market is vulnerable to an air pocket in the coming weeks if there’s disappointment from one of the three market influences.
Feel free to use me as a sounding board.
Kurt S. Altrichter, CRPS®
Fiduciary Advisor | President
Direct: 952.828.5336
Email: kurt@ivoryhill.com
—Written 09.07.2021.
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