Another Snapback Rally
/September gave the U.S. equity markets its worst selloff since November of 2020. In my last Private Client Letter from one month ago, I observed that “a turning point may be nearing” as October is historically a positive month.
Well, this turning point came just one day into October and the broader U.S. market averages went on to end the month at record highs. The NASDAQ Composite was the big winner for the month, posting a 7% gain. The S&P 500 and the Dow Jones Industrial Average also moved about 6% higher in October. As November gets underway, all three indices have posted an impressive four-week winning streak.
We’re now past the halfway point of the third-quarter earnings season and 82% of companies have exceeded profit expectations to date. Earnings growth remains very strong, with the current earnings season on track to show growth in excess +35%. I expect the fourth quarter of the year will see earnings growth of +20% or more. This pace of growth may be slowing from the first half's breakneck speed, but it is still very strong by historical standards.
Many skeptics have been discounting the strong earnings growth rates and point to what they believe are stretched aggregate valuation metrics. My view is that earnings will continue to grow above trend well into 2022 and the rally we have enjoyed this year will be sustainable.
We are seeing a favorable trend for 2022 earnings estimates. In fact, full-year 2022 estimates have gone up by more than +25% since the start of the year and more than +14% since June 30th. Corporate profitability has significant momentum, and the positive trend will only accelerate as the full extent of the economic reopening takes hold.
Economic indicators from consumer confidence to unemployment claims improved in October. The fundamentals of our economy remain strong and there is no reason for the rally to lose ground if interest rates remain stable and corporate earnings maintain their current uptrend.
My forecast for full-year economic growth in the U.S. has stood at about 7%. Over the past few months supply chain disruptions and the effects of the COVID-19 delta variant have slowed economic activity substantially. The economy grew at only a 2.0% annual rate in the third quarter, following 6.5% growth in the first half of the year. Things should pick up in the current quarter and I now expect full-year 2021 GDP growth to be in the neighborhood of +5% and around +4% or more next year.
Eventually, Fed Chair Jerome Powell will announce the tapering of the Fed’s $120 billion monthly bond buying activity. This is now a widely expected development and necessary to contend with increasing inflationary pressures. Market reaction to such an announcement will likely be muted and I do not expect a “taper tantrum” type selloff.
The Fed has fallen behind the curve relative to inflation as price pressures are now higher than anytime since the 1980s. This said, interest rates overall remain historically low and are likely to rise only gradually for the foreseeable time.
The last days of October brought a great deal of uncertainty relative to two significant pieces of infrastructure legislation in Washington. The Democrat controlled House of Representatives failed to take up the Senate approved $1.2 trillion bipartisan bill and President Biden’s original $3.5 trillion Build Back Better proposal was scaled back to $1.85 trillion which includes an additional $100 billion in immigration spending.
Still, negotiations amongst Democrat law makers have stalled (no Republicans have signaled support of the Build Back Better agenda). Some politicians have claimed that these bills will “cost zero dollars” and not add to the national debt. A final Build Back Better bill isn’t yet written and at this point it is impossible to assess how it might affect debt levels. Of course, the claim of zero cost is entirely contingent on new taxes that would offset the new spending. In other words, the legislation will cost some high earners through higher taxes.
Our observations relative to these two pieces of legislation is not intended to be political; we maintain a neutral stance on all political matters. This said, legislation of this magnitude will have a profound impact on the U.S. economy.
It can be difficult for most people to understand just how big these numbers are. Millions and billions are one thing, but when it comes to trillions “perspective” is particularly challenging. If we were to equate dollars to seconds in time, we more easily see how enormous this proposed spending is. A million seconds ago it was mid-October, a billion seconds ago takes us back to 1989 – or about 32 years. However, a trillion seconds ago takes back to a time when cavemen walked the earth – about 31,000 years!!
Pundits will hotly debate whether the proposed spending is a net positive, or a net negative, for the economy. Either way, no one can debate how significant this level of spending is – no matter who is paying for it.
There are now just two months left in the year, and, from a seasonal perspective, November and December have historically been two of the better months on the calendar for U.S. equities. The S&P 500's 22% gain this year is the strongest year-to-date reading through October since 2013 and is just the tenth year since 1928 where the S&P 500 has been up more than 20% YTD through October. In prior years where the S&P 500 was up 20%+ in the first ten months of the year, performance in November and for the remainder of the year was positive every time (Bespoke).
Will the balance of the year see equities trade higher? We will see. Our year-end target for the S&P 500 stands at 4,815. More importantly, we believe equity prices will continue to trend higher in 2022.
Thank you for your continued confidence in Clearwater Capital Partners. Please do not hesitate to reach out to us if you have any concerns or should you wish to discuss our strategies in greater detail.
John E. Chapman
November 2021
