Support for stocks, beyond the calendar
By Kyle Tetting
While I typically stress a longer-term view, earnings forecasts and market prognostications tend to be centered around the time it takes the earth to travel around the sun.
It aids the narrative to think in calendar-delineated snippets of time, even when they hide broader trends. Unfortunately, it also creates untenable views of our investments. It creates high-water marks at the end of each quarter and ties our outlook only to immediate expectations of the next 12 months.
The current pandemic shows shortcomings in those tidy calendar-year forecasts, especially how expectations for the year can shift quickly as major events develop.
For example, the extent and scope of the pandemic will not neatly cease at the end of a quarter. Its impact has affected investments unevenly. Forecasts call for earnings to recover prior record highs in the quarters ahead, but the exact timing depends on a variety of factors that put a likely recovery anywhere between late spring to next winter.
Also, the calendar focus on near-term outlook can hide longer-term views, including well-founded optimism for stocks. Though the exact timing of a recovery remains elusive, the broader expectation provides continued support for stocks, led by earnings.
Forecasts. Earnings are expected to surpass $200 per share in 2022, according to data from Refinitiv, growing more than 50% in the span of five years. Since the magnitude and direction of stock price movement tends to mirror earnings over time, the expected earnings growth in that five-year stretch, exceeding 10% a year, offers a foundation for strong stock returns.
Valuations. The forward price-to-earnings ratio for the S&P 500 — currently around 21.3 times forward earnings — sits about 28% higher than long-term averages. However, stretched valuations are not atypical early in an earnings recovery as forward-looking measures include near-term periods of weakness rather than the full impact of the expected recovery.
Alternatives. Further, less attractive alternatives to stocks allow for higher valuations as investors are more willing to embrace stock market risk for the potential for higher returns. Consider the yield on Treasury bonds, for instance. Interest rates have moved markedly higher this year, yet the benchmark 10-year Treasury note still yields less than 1.5%. Retirees who count on 4%-6% returns cannot rely on bonds alone.
Moderation. Exuberance for stocks has not risen to a level of concern. Personal savings rates have climbed, plenty of dry powder remains for investors, and market sentiment still suggests investors are cautious. The Investor Sentiment Survey, published by the American Association of Individual Investors, showed bullish sentiment at a nine-week high in mid-February. While optimism has risen a bit beyond long-term averages, it remains well below mid-November highs.
Breadth. Even within stocks, there are vast differences. The forward price-to-earnings ratio of the top 10 stocks in the S&P 500 is around 31.3. The other 490 stocks carry a forward P/E of just 18.7. The breadth of participation in market rallies seems to have widened in the first two months of 2021, with value stocks reclaiming some of their lost luster.
Speaking broadly and with a long-term view, there is more optimism for stocks than many are letting on. However, participation in that optimism requires more than just a dependence on what has worked well so far, and it might mean putting up with a bit more short-term volatility again.
Limiting our discussions to calendar-year outlooks can put too much emphasis on the near-term risk, which may cause us to miss out on the long-term gain. On the other hand, failing to acknowledge the near-term uncertainty leads to unnecessary portfolio swings.
Recognizing that volatility will persist and that there are diminishing returns associated with risk taking, we must continue to embrace balance in our portfolios. In minding our mix of assets, we continue to weigh the long-term benefits of stock exposure against the very real uncertainty of this pandemic.
Kyle Tetting is director of research and an investment advisor at Landaas & Company.
A note on coronavirus volatility, by Kyle Tetting
Keeping balance in unnerving times, by Bob Landaas
Checklist for circumstances beyond control, by Joel Dresang
(initially posted February 26, 2021)
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