Macro overview

RBC’s capital markets team expects S&P500 to continue its recovery at a modest pace in 2021 and has set the year-end S&P500 target at 4,100 which amounts to a 9% gain from the end of 2020. The S&P500 has historically returned around 9% when GDP growth exceeded 4%. The U.S. economics team projects 2021 GDP growth of 5%. Tactically, a short term market pull back is still very likely given much of the optimism of the stimulus measures and positive vaccine news have been priced in by the markets.

 

Looking back at 2020, amidst the panic selling and the onslaught of bad news, it was difficult to imagine a swift recovery. However a V shaped recovery in industrial activity was real as lockdowns eased in the second quarter.

 

The important question for 2021 is how effective the vaccines are and can we ease the lockdowns further to realize the anticipate rebound in GDP growth.

Source: Fidelity, Purchasing Managers Index, Refinitiv DataStream, Dec 31, 2020

 

Earnings

The headlines and news cycles focus on the prevailing sentiments in the markets. You may find yourself swayed from extreme optimism to pessimism in the blink of an eye. Despite the unpredictability of market sentiments, some relationships remain reliable over the long term.  

 

Share prices have risen with earnings

 

To sustain the market rally, we will need to see further evidence of earnings growth and recovery. The S&P500 consensus earnings forecast is $168 per share for 2021 and would represent roughly 20%y/y growth after the final 2020 results shake out. If this is achieved, it would push profits beyond the pre-Covid-19 high of $163 per share reached in 2019.

 

The S&P500’s valuation of 21.2x the forward consensus earnings estimate is uncomfortably above average, but valuation alone should not prohibit the index from advancing given the interest rates are likely to remain extraordinarily low.

 

Price-to-earnings (P/E) ratios of major equity indexes

Sources:Bloomberg, Refinitiv I/B/E/S (S&P500); data as of 11/23/20; represents forward P/E ratios based on consensus earnings forecasts for the next 12 months

 

IMF expects US and China to recover most strongly from virus economic hit, given the gap in relative valuations, we have observed a rotation of institution investments into the Emerging Markets in recent months.

Lots of attention are paid on the elevated valuation in the Equities markets, however, given the extraordinarily low interest rates, the current Fixed Income valuation is much higher on an implied P/E basis.

 

Energy sector rotation – what’s old is new again?

RBCCM’s updated Brent/WTI estimates now sit at $54/$52 in 2021 (was $48/$46), and $60/$57 in 2022 (was $55/$50)

RBC CM is not the only investment house putting Energy sector on the radar for investors again. This much unloved sector faces many structural headwinds and no doubt many of the Canadian investors still lament their lagging energy positions.

There is hope on the horizon, RBC and JPMorgan, Credit Suisse have overwhelmingly upgraded three of the 2020 lagging sectors to overweight for 2021, they are Financials, Materials and Energy sectors.

 

GameStop – fundamentals be dammed?

No doubt much has been said about recent crowdsourced actions on some of the names such as GameStop, AMC or U.S. airlines. As a covid recovery play, these may have fundamental underpinnings. However, rational investors who are determined to generate a return in a sustainable way can find it difficult to understand the end goal of such market disruption without clear analysis or thoughts about valuation. The speculative trends may continue as more retail investors enter the market and behave in a more unpredictable way. Speculatively excess has traditionally been a warning sign in maturing bull markets and need to be monitored carefully.