3RD QUARTER NEWS
We wrote three months ago about the potential for the high flying stock market to feel the force of gravity. That statement seemed unfounded until, wham bam, we hit the month of September and saw a 4.8% decline in the S&P 500. It now seems we are in for a bit of a grind during the period immediately ahead.
Market analysts often talk about the “wall of worry.” That is a crowded wall at the moment: anxiety over future monetary policy; the impact of the Delta variant on economic growth; supply chain bottlenecks; the prospect of sustained inflation; problems in the Chinese economy; and Washington’s political gridlock over taxing and spending policies and the national debt limit.
At Hudson Advisors, our anxiety is higher on some of these items than on others. On the positive, we think the economy will grow well despite the prolonged pandemic. We think the Federal Reserve will act carefully as it tightens monetary policy. We think Congress will extend the debt limit. That said, we are uncertain when supply bottlenecks will improve and how that situation affects inflation. We are uncertain about the impact of whatever happens with the Biden domestic agenda. We are uncertain about China’s shifting regulatory policies over technology and real estate.
We share the viewpoint that the market will bump along in a narrow trading range for the rest of 2021 and into early 2022. We are not concerned about a major retreat. But we do not think the market can accelerate until some of the “worry wall” items are clarified. As always, we will manage in this climate to find the best long-term opportunities for our clients.
The Economy: The U.S. economic recovery is fully underway although slowed by the Delta variant. The forecast for expansion of GDP in 2021 is now 5.9% according to the Conference Board. Earlier they had forecast growth for the year at over 7%. The recovery is uneven across economic sectors with travel and entertainment effected most negatively by the prolonged effect of Covid 19. Small business is suffering from labor shortages and the disruptions in the supply chain, much of it related to problems in international shipping, are slowing some economic activity. Those disruptions have also pushed inflation above 5%.
Looking ahead, the Conference Board sees GDP growth of 3.8% in 2022 and 3.0% in 2023. This annual growth rate is much healthier than in most of the decade prior to the pandemic. The U.S. consumer is at the center of this positive outlook.
The Market: Because of the core economic strength, corporate earnings are healthy. Most companies in the S&P 500 have exceeded earnings forecast. Many companies will have annual profit growth in excess of 20% for this year compared to 2020. As the economy normalizes in 2022, those earnings are expected to be in the 10% range – which is still a good performance.
Many investors ask if the market is overvalued at the current time. Are stock prices too rich? At present, the forward price/earnings ratio for S&P 500 companies is 22.04. Because of the good corporate earnings, that number is below the high of 23.6 on August 28, 2020. Historically, the P/E ratio has been in the range of 13 to 15. So, yes, stock prices have come down somewhat in the past year, but are still quite rich.
As stated, because of the positive economic and earnings outlook, we do not expect the stock market to see a major pullback. But we do think it will be difficult for the market to move much higher in the months ahead given the rich price of stocks and all the issues causing anxiety. We think the market will be especially nervous about tightening monetary policy by the Federal Reserve. We expect the rest of 2021 to see a flat and sometimes choppy performance.