“In our view, in the ongoing rotation into cyclicals, the S&P 500 could definitely overshoot the February 2020 all-time high”, SocGen’s Sophie Huynh writes, in a lengthy Q3 US equity outlook piece released on Wednesday.
The bank’s view remains that the benchmark may rally beyond 3,500 between now and the end of the year, before ultimately pulling back to fair value, which SocGen says is around 3,300.
A move up to 3,500 would represent a ~60% gain from the March COVID panic lows. Remember, the index has already moved 10% above the average Street year-end target.
It’s remarkable (to say the least) that 3,500 on the S&P by year-end not only seems possible, but just as likely as not. With Jerome Powell having made it clear that the Fed is “not even thinking about thinking about” raising rates (and no, there are no typos in there), and the dots showing lift-off is two years away, policy support is assured – or at least barring some manner of furious upside inflection in growth, which one assumes would be good enough on its own to justify higher equity prices, rate hikes or no.
Of course, the Fed also committed to buying at least $80 billion per month in Treasurys and $40 billion per month in MBS for the foreseeable future, and will likely institute some version of yield-curve control before the year is out. That too is supportive for risk.
“In our view, investors should not underestimate the search for yield, as well as P/E expansion, in the early stage of the new economic cycle”, Huynh goes on to say. “Meanwhile, market participants still have some cash to deploy in the short term”.
Critics continue to fret that this is unsustainable, but it could very well be that the marriage of fiscal and monetary policy make the current dynamics far more durable than those which pushed risk assets inexorably higher in the post-financial crisis years. After all, the strange combination of easy monetary policy and austerity in some locales amounted to driving with one foot on the accelerator and one foot on the brake, which is generally inadvisable. That manifested in lackluster growth and inflation outcomes alongside financial asset bubbles, a state of affairs which left equities (and other assets) even more detached from the real economy than they were previously.
At least now, there’s some hope that with fiscal and monetary policy on the same page, real economic progress is possible.
“Markets tend to be keen and quick to price-in worst-case scenarios when bad news occurs, and then take time to climb the wall of worries, which makes for a bull market”, SocGen’s Alain Bokobza wrote, in a separate asset allocation piece out Wednesday. “In the second half of this year, we expect markets to continue pricing in a combination of falling virus cases, rising PMIs, and continuing fiscal injections — this time with no early austerity — while central banks buy the equivalent of new issuance (and probably more) for longer”, he added.
I cannot emphasize enough how crucial it is that “early austerity” doesn’t short-circuit this recovery as it did following the last crisis. The worst possible policy outcome would be for central banks to be left on their own again. If budget hawks insist on austerity and win the day, the onus will be back on central banks, and the result will be even weirder juxtapositions between fiscal belt-tightening and monetary largesse.
For her part, Huynh explains the rally in US equities (which she notes is the fastest recovery since 1870), by reference to the adoption of “near-MMT (fiscal) and monetary injections” which she notes “surprised to the upside by their size and speed, directly impacting asset prices”.
Those of you who read every post in these pages will recall that on Tuesday, I talked a bit about the problems with bonds in a balanced portfolio when yields are so low. According to Morgan Stanley’s estimates, benchmark yields across developed markets would have to plunge deep into negative territory to offset a hypothetical double-digit decline in equities.
Another way to think about this is that as bonds become less reliable as diversifiers, it forces investors into defensives and other equities which can proxy for bonds.
SocGen’s Huynh mentions that dynamic as well. “The ever-lower interest rate environment and the conundrum of how to manage a multi-asset portfolio (especially a 60/40 portfolio) with 10y UST below 1%, forced investors into the equity complex by default, through bond proxies”, she writes.
(SocGen)
Obviously, secular growth, defensives and duration outperformed mightily during the panic.
The narrative abruptly shifted over the past couple of weeks, as reopening optimism and a steeper curve catalyzed an epic rotation into value and cyclicals, but the fact is, the world would be a scarier place for equity investors in 2020 if it weren’t for Facebook, Apple, Amazon, Netflix, Microsoft, and Alphabet.
If cyclicals, value, and all the other sectors and styles that have lagged for what seems like an eternity can take the baton (and avoid dropping it as they have on so many occasions previous), the rally may have legs, contingent on the reopening process not getting derailed.
Remember, the tech behemoths arguably don’t have much gas left in the tank in terms of getting more expensive, even if they continue to grow the top- and bottom-line when no one else can. Early in May, for example, Goldman argued that the FAAMG stocks collectively had just 3% upside to the banks’ targets. Credit Suisse, on the other hand, thinks tech can get more expensive still, as investors pay up for growth.
Read more:
Goldman: FAAMG Upside Now ‘Just 3%.’ Rest Of Market Has To Step Up
SocGen’s Huynh has been calling for a rotation into cyclicals since at least the last week of April, and although it faltered on Tuesday and Wednesday, you can make the case there’s more to come.
“Our baseline scenario of a gradual economic recovery, currently protected by loose fiscal and monetary policies, should pave the way for further upside on the US equity market”, Huynh goes on to write, before declaring that in the bank’s view, “all the stars are aligned [as] the start of a mini-cycle calls for cyclicals to be favored, on top of which they do not yet fully price in a V-shaped recovery”.
The figure just shows that the sectors in red still have some catching up to do, assuming the recovery is, in fact, robust and sustained.
(SocGen)
SocGen continues to prefer mid-caps to the Nasdaq 100, in a reflection of expectations for a continuation of the nascent cyclical surge.
Meanwhile, the bank’s Alain Bokobza has a question: “If the Fed is reluctant to go to negative rates, will it prefer to buy equity ETFs to facilitate balance-sheet repair instead, in case another market rout were to develop?”
A bit more context required re: “If the Fed is reluctant to go to negative rates, will it prefer to buy equity ETFs to facilitate balance-sheet repair instead, in case another market rout were to develop?”. Whose balance sheet would the Fed be repairing, and how would the ETF buy action support their primary mandate?