S&P 500 looks on track for 5,000

The S&P 500 passed a series of milestones last week, reaching its 50th all-time high for 2021, already more than in each of the past three full years.

In crossing 4,500 for the first time, the index also increased its gain for the year to 20%. The achievement of this striking series of round numbers may seem surprising given the release of mixed US economic data in recent weeks, including weak retail sales figures for July, along with disconcerting COVID-19 developments. Globally, infections have risen for nine consecutive weeks, based on data from Johns Hopkins University. The US daily death rate has started to climb above 1,000 for the first time since March.

But we see several reasons that stocks can advance further, and we now expect the S&P 500 to reach 5,000 by the end of next year:

1. The S&P’s rally has been underpinned by robust earnings growth, and this run of strength should continue.

• For the fifth quarter in a row, S&P 500 earnings results have been much better than expected. With almost all companies in the index now having released second-quarter results, more than 85% have beaten earnings and sales estimates. Aggregate corporate profits are up nearly 90% from year-ago levels. This easily tops our original estimate for 80% corporate profit growth, and is much stronger than the typical recovery from a recession. In fact, earnings are now nearly 30% higher than pre-pandemic levels, which helps explain why stocks have performed so well.
• There are also good reasons to expect continued profit growth ahead. We expect revenues to be supported by robust consumer and business spending. Consumer balance sheets are the strongest in decades after households amassed significant savings over the last year. In addition, interest payments as a percentage of disposable income are running at around 8%, versus around 10% prior to the pandemic. Meanwhile, businesses are struggling to keep up with demand, suggesting a long pipeline of investment projects and a need to rebuild inventories, both of which are supportive for the growth outlook. Finally, S&P 500 profit margins hit a multi-decade high in the second quarter at close to 14% despite rising input costs for many firms. Margins should be supported as the supply side of the economy begins to catch up with demand.

2. Top Federal Reserve officials at last week’s Jackson Hole symposium restated that policy will remain supportive, even after bond purchases are scaled back.

• In his speech last week, Federal Reserve Chair Jerome Powell continued the process of gradually preparing the market for a tapering of quantitative easing, while indicating that rate increases are not imminent. “The timing and pace of the coming reduction in asset purchases will not be intended to carry a direct signal regarding the timing of interest-rate liftoff, for which we have articulated a different and substantially more stringent test,” Powell said. The Fed’s gradual approach aligns with our view that policymakers are eager to avoid a repeat of the 2013 taper tantrum, when unexpected talk of tightening caused a sharp rise in yields and a fall in stocks. Instead, on Friday, the S&P 500 was up 0.9%, while 10-year Treasury yields moved lower to around 1.33%, and the dollar fell.
• Our base case is that the Fed will reduce its asset purchases, currently running at USD 120bn per month, by USD 15bn each month starting in December.

3. Progress toward economic normalization—though uneven—continues.

• Notably, we were encouraged last week by news that China had reported zero domestic COVID-19 cases for the first time since July. The authorities also reopened the Meishan terminal at the world's third-busiest container port following a two-week shutdown. These developments reinforce our view that the recent setbacks in China’s efforts to combat the pandemic will be overcome without a significant disruption to international supply chains or a boost to global inflation.
• Globally, the pace of vaccinations accelerated last week to around 38 million daily, below the peak in June of 43 million, but up from around 20 million in May, according to Our World in Data. Meanwhile, studies continued to show that vaccinations are weakening the link between infections, hospitalizations, and deaths. Countries earlier in their delta wave—including the Netherlands, Portugal, and Spain—are bending the curve.

So, while risks remain, and investors should reflect this in their portfolios, we believe the backdrop for equities remains positive, and we advise investors to position for reopening and recovery. Our S&P 500 targets are 4,800 for June 2022 and 5,000 for end-2022. We advise investors to position in stocks that should benefit from strong economic growth. At a sector level we prefer financials, which should be well-supported by rising 10-year Treasury yields, and energy, which we expect to benefit from a further rise in oil prices in the second half of the year. We like Japanese stocks as their revenues are highly exposed to the global recovery.

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