S&P 5,000 By June (Or By Friday)

The S&P has a date with 5,000 by… well, by the end of the week if Monday and Tuesday were any indication.

I’m just kidding. You can’t divine much from the price action at the current juncture. It’s more noise than signal.

“Equities, as the saying goes, are ‘trading short,'” Nomura’s Charlie McElligott said Tuesday, before running through a list of remarkable statistics, including anomalous exposure reductions from the asset manager community, nearly $95 billion in global equities de-leveraging from CTA trend over two weeks, $64 billion of selling from vol control over the same period (figures below) and the well-documented tribulations of hedge funds amid painful factor tremors.

Looking through the fog (i.e., variant concerns and Fed fears notwithstanding), US equities are headed markedly higher through the second quarter of next year, according to UBS, whose Keith Parker and Alastair Pinder expect the global risk asset benchmark par excellence to peak at “5,000+” in the second quarter.

Their rationale, set out over 40 pages, is (refreshingly) straightforward. “S&P 500 consensus growth expectations for ’22 are low relative to history and in particular Q4 ’21 estimates are ~5% below Q3 ’21 actual EPS providing a low bar into early next year,” they wrote, suggesting a double-digit increase in forward earnings over the next six months combined with “still strong” economic growth and falling COVID cases (remember, this is a year-ahead outlook piece, not a tactical call on the next two weeks) should support stocks at least into the summer.

Of course, multiples are (hopelessly?) stretched, and that doesn’t bode particularly well in an environment where the Fed is predisposed to tightening on inflation fears. If breakevens continue to moderate (as markets price in a prospective policy error, for example), the read-through is higher real rates — colloquially, “kryptonite” for richly-valued corners of the equity market.

“It’s no coincidence that the most highly-valued stocks have seen the biggest hit over the past few weeks,” Morgan Stanley said Tuesday. Like me, the bank’s equity strategists insist that tapering is tightening. That, in turn, presages lower valuations (figures below).

Morgan sees the S&P’s forward multiple falling to 18X “with a larger decline for the more expensive parts of the market.”

For their part, UBS doesn’t doubt a de-rating is in the cards as real yields move higher. Indeed, Parker and Pinder said “valuation headwinds in 2022 will likely be greater than typical years as real yields rise [and] the Fed tapers.”

However, at least in the first half of 2022, UBS reckons that “a decline in the multiple as real yields rise [will be] more than offset by higher earnings.” Q2 profits should be ~$60, according to the bank’s framework. That’s well above consensus.

“That >$240 of annualized EPS points to 5,000+ for the S&P 500 by Q2 on a 20.5 P/E,” UBS said, but cautioned that “further tightening of financial conditions, continued cost pressures and slower growth in H2 ’22 points to a flattening of EPS growth thereafter to below trend levels and a more notable multiple de-rating.”

Ultimately, UBS’s year-end 2022 target is a more modest 4,850. The simple table (above), summarizes things.

So, what happens between now and year-end 2021?

Well, that’s anyone’s guess. If you ask Goldman’s Christian Mueller-Glissmann, risk appetite needs to deteriorate further to create a real buying opportunity. The bank’s indicator, while loitering near post-COVID lows, could drop further, Mueller-Glissmann told Bloomberg, in an interview. “Without any view on better macro you would want the RAI closer to -2 before adding risk,” he said. (It’s hovering near -1 currently.)

UBS’s Parker and Pinder cited the bank’s machine learning model in noting that “the risk/reward for US equities was tilted to the downside in the near-term” with the “key risk” being tighter financial conditions. Fed policy is now the “most important factor driving stocks.”

As for Omicron, they simply noted that “the variant complicates the setup further as the pace of COVID cases has still mattered for equity returns, albeit less than early this year.”