Second Half 2021 Market Outlook
Let the Good Times Roll
Nearing the final weeks of the first half of 2021, the S&P 500 sits near 4225, slightly exceeding our “Sell Tax Day and go away; you’ll miss largely nothing for the next few months,” view we expressed in April via our podcast. The S&P500 closed at 4185 on Friday, April 16th. So for all the worries and alarmist stories on inflation or commodity shortages, the market is pretty close to net flat the last 2 months. In our view: welcome to a normal 2nd quarter.
In our first half 2021 Outlook piece, and with the S&P 500 siting around 3700, and on the back of the “Who won the 2020 Presidential election” debate continuing on most TV networks, the investment team at OHFG stated, “We continue to see an accelerating short term up move in equities into the early part of first quarter of 2021 with a move above 4000 on the S&P 500 possible.”
In February 2021, the S&P 500 reached 3950 and 3983 in March, and promptly declined 5.75%. Post that decline, the S&P500 staged its normal strong seasonal rally into tax week in mid-April after a strong 1st quarter earnings report and stock buyback window. While the S&P500 has eked out new all-time highs over the past two months, it has done so in a very frustrating manner to most tactical investors and almost every analyst we have heard on TV.
The common themes being parroted in the second quarter have been that given the reopening of our national and international economies, TV commentators and most asset allocations said investors needed to overweight value versus growth, small caps versus large, be long on commodities and international markets over domestic. And what, of course, has transpired the last month to get us to new marginal new ATH’s? Prices of commodities like lumber and timber have been topping, while grains have been plowed under, and iron ore has been melting down. Just as interest rates have rallied, the yield curve has flattened, inflation breakeven rates have declined, and growth stocks have outperformed value.
Almost uniformly, economists were calling for higher long-term interest rates. And what has happened since Tax Day? And even more so since mid-May? Long-term interest rates have rallied and fallen lower, leading to a flattening of the yield curve led by a slowing of long-term inflation expectations. Moreover, while most analysts keep pontificating on high levels of volatility, volatility has declined from the low 30’s to the mid teens.
So where do we sit now and what is our outlook for the second half? We make no bones about it: We are in a bull market, and, while very short term, our analysis continues to point to the possibility of a minor pullback of something in the 5 to 6% range. Based on the current price of the S&P 500, that would present a downside range of between 4000-4050. This would equate to a spike in short-term volatility to the 28-30 range and volatility futures into the 26.5-27.5 range. However, there is a good chance now that we do not see that, given we have navigated the June Federal Reserve meeting pretty much without a scar.
We have discussed historical analogies for 2021 in several different mediums, including our weekly market updates and weekly podcasts, with the two years most similar in timing this cycle being 2013 and 2017. In both periods, the S&P 500 ended up almost 38% trough to peak from election 2012 and 2016 into a peak in the first quarter 15 months later in 2014 and 2018.
Right now, the model of 2013 President Obama round #2 continues to be eerily similar, with a very similar same pattern and timing regarding the price action in the market. Whether its commodity moves, interest rate moves, inflation moves, real growth moves and sector rotations; our view is that things are progressing normally for this cycle.
Due to the Federal Reserve’s fiscal support being similar to their early QE programs under President Obama, as well as the gridlock in Congress that President Biden is now experiencing in his first term, Oak Harvest does not find this surprising.
On the upside, we continue to see very strong second half stock returns for 2021, hence our title taken from the Cars Classic, “Let the Good Times Roll”. By strong, we mean a summer rally projection of 4400 on the S&P 500 is possible post-second quarter earnings reports as companies buy back stock. By then investors should become increasingly certain that Federal Reserve Jerome Powell will continue to make all the right moves. We are in a bull market, and contrary to others call of “unprecedented” times, this bull market, outside of its speed of recovery in 2-4thquarter of 2020, sits at just over average as returns go so far.
Per Merrill Lynch statistics, our current bull market that started on March 23rd at an S&P 500 of 4225, out of the 26 bull markets since 1928, with returns in excess of 20% before having a 20% correction, is the 11th strongest bull market at just over a 90% total return. The average return of the 26 bull markets was 113.5% equating to around 4770 on the SP 500 if we just got to average and the average length would push this run out to December of 2022.
With these things in mind, our year end view of a possible move over 4600 on the S&P 500 seems not only attainable, but perhaps even conservative looking at valuations, earnings, options markets, and investor demand for equities. If pressed, we would say that spot volatility returning to 12 into the seasonally strong 4th quarter 2021 and 1st quarter 2022 time period could potentially lift the S&P 500 over 4800-4850, and could even approach 5000 in a blowoff in January of 2022. Far from “unprecedented”, this would be similar to both first quarter 2014 and first quarter 2018.
The team at Oak Harvest messaged mid-2020, we expected a strong pre-election 4th quarter and early 2021 stock market rally and economic strength because the Federal reserve was providing ample liquidity to financial markets. At the same time, we had faith in the scientific community’s ability to figure out the virus in a timely manner.
What was the team at Oak Harvest doing back then? We were using real time data and our team’s collective knowledge and experience, not emotion or nebulous arguments, to help guide our decisions. We are doing the same now. At Oak Harvest, the investment team - by way of our weekly podcasts, weekend updates, and emails - are trying to keep you ahead of the curve. We are trying to help you see what might be around the corner before others do or give you some answers to questions even before they are asked.
Given the lag effect of Federal Reserve monetary policies on real economic growth and inflation, we expect a positive pickup in growth and real interest rates in the second half of 2021, without a significant impact on stock valuations. The team at OHFG believes there is far too much attention being placed on the minutia of Federal Reserve moves and the timing of tapering and tightening monetary policy in the future. Looking at the correlation of the Federal Reserve balance sheet expansion and the returns of the S&P 500, one will see that even during actual time periods of “tapering”, S&P 500 stock returns were impressively positive.
The latest round of declining real growth started when Fed Chairman Powell made his mistake in November of 2018 and stated he was “not even being close to done tightening monetary policy”. We don’t expect him to utter any hawkish statements on interest rates unless we have a short-term exponential move in stocks over a 3-to-4-week period, which isn’t likely until early 2022.
What do we think works in the second half of 2021 on the way to materially new all-time highs? Well after an upwardly-biased, choppy 2nd and 3rd quarter, we think everything goes higher in the 4th quarter 2021 and January 2022 led by traditional growth stocks, higher growth-at-any-price stocks, and financial stocks as the economy comes off its Covid recovery-induced reopening high and big institutional money looks to position for slower economic growth in 2022.
Names with high and sustainable revenue growth, margin expansion, and low debt are likely leadership names much as they have been since the great financial crises in 2008-2009. In addition to outgrowing inflation fears, these companies can stave off the fog of higher corporate taxes by investing in their businesses by way of spending on both people and capital investment, increasing depreciation expense, and shielding some pre-tax income from Uncle Sam.
The companies and stocks that have historically been most at risk from higher trending interest rates and/or higher corporate tax rates are those slower growth, higher dividend paying companies. Why? Because these companies tend to be slower-growing companies in slower-growth industries. These high dividend paying companies, whose dividend payout ratios tend to be very high, already pay a high percentage of their after-tax free cash flow to shareholder for dividends. If they are forced to pay higher corporate taxes, they have less free cash flow available to pay dividends.
There you have it. Our team is looking forward to another good to great 6 months of overall stock market returns, very similar in magnitude as the 2nd half of 2020 and the 1st half of 2021.
This concludes our second half outlook.
Though all data and information included in this outlook is believed to be accurate as of the time of publication, it is not guaranteed and no assurance of its accuracy is provided. Nothing in this forecast should not be considered personalized investment advice. All charts, indicators, or graphs included or referenced in this content have limitations. No such material is able, in and of itself, to provide a buy or sell recommendation for any security. Strategies discussed will not apply to all client accounts or portfolios. No assurance is made that Oak Harvest Investment Services will continue to hold the views expressed herein. Views and opinions may change based on new information, analysis, or reconsideration, and without notice. . Not all past forecasts or projections were, nor future forecasts and projections may be, as accurate as any forecast discussed. Oak Harvest makes no assurance as to the accuracy of any forecast or projection made. Investments or strategies mentioned may not be right for you. Direct investment in an index like the S&P 500 is not possible, and returns of an index like the S&P 500 will not reflect the costs associated with an actual investment portfolio. Returns of an index will not reflect the results seen in your portfolio and your results will differ. Any investment strategy depends on your personal situation, risk tolerance, and objectives and should be undertaken after consulting with your financial advisor. Past performance is not indicative of future results. Investing involves the risk of loss.
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