By Paul Brighton, Portfolio ManagerSummer is winding down as we get close to the Labor Day weekend. Schools are reopening and fall football and the month of September are right around the corner. By happenstance, September can be a difficult month for equity markets. This brief commentary will be a gentle reminder of the possible choppiness and why it’s important to look past the volatility and the ever-present negative news-cycle headlines. It is far better to stay focused on the strong fundamentals that are still in place.
The S&P 500 is up a very strong 19.4% year-to-date and an even stronger 103% since the March 23, 2020 low at the depth of the pandemic-engendered selloff last year. That being said, we haven’t had a drawdown in the market of 5% or more since October of last year (from Oct 12th through Oct 30th the S&P 500 declined by -7.43%). Early Fall has been a seasonally challenging time of the year for the market. Over the past 92 years – going back to 1928 – September has been the weakest month of the year averaging a return of -1.0% with 50 out of the 92 months being negative. (Of course, since there are only twelve months in the year and they are highly unlikely to be equally good or bad, one must stand out as the worst, but that’s a worthless forecasting tool.) Statistically, a pullback of something more than 5% would not be unusual; such declines are common. If it happens, it could be viewed as somewhat healthy in that it can reset expectations and valuations which in turn can allow the market to resume its path higher as it discounts future earnings growth of about 9.2% for 2022. The market has averaged about 7.9% annual earnings growth over the last 10 years.
Market headlines and concerns that may be affecting investor sentiment include higher tax rates (corporate and capital gains in particular), higher inflation (the bond market seems to be indicating that it may be mostly transitory), the supply chain issues which continue to be affecting many parts of the economy, and an upturn in Covid cases. These four issues are widely known and you could argue they’re already being discounted by the market. The delta variant is obviously a concern, but new cases in the U.S. are expected to peak in coming weeks. This doesn’t mean that it’s gone or going away completely, but again the market is aware of this and it appears already to be factored into stock prices. We may also need to deal with any new variants on a go-forward basis.
The current S&P 500 valuation of 20 times forward earnings looks high relative to the average over the last five years of 17x, but not when adjusted for prevailing interest rates. The 10-year Treasury rate of 1.26% is much lower than the average of 1.97% for the past five years. Note, however, that the current earnings yield on the S&P 500 of 4.93% looks very attractive compared to that 10-year yield. And Bloomberg’s full year 2021 GDP is forecast to be well above long-term trends at 6.2% and to remain above trend at 4.3% in 2022. These are really strong GDP numbers that will support continued solid growth in corporate earnings. Also, it’s worth noting that we still have extraordinarily supportive monetary measures in the system and a bipartisan infrastructure bill may be passed in the coming months. As noted above, September can be a volatile month for the market, but the economy is strong and the outlook over the next few quarters is as well.
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