On a strange day in an even stranger year, the market reached a pandemic milestone. Monday July 20 saw the S&P 500 finish the session slightly ahead of June 8’s close, marking a new pandemic high. In the following two sessions, it extended its winning streak. Progress in the advancement of a COVID-19 vaccine certainly played a role, but did something else contribute as well?
Head of U.S. Equity Strategy for RBC, Lori Calvasina, believes that the anticipation of a stimulus package produced a more meaningful impact as tech and growth stocks were at the front of the pack. This is somewhat counterintuitive given that a true light at the end of the pandemic tunnel would be more likely to cause these stocks to lag.
The implication? Calvasina now sees some upside to her original year-end S&P 500 price target, with the strategist bumping up the figure from 2,750 to 2,900. However, even if this scenario ultimately plays out, it would still reflect a dip of 11% from current levels and a 10% decline for the year, with Calvasina’s estimate also landing below the consensus of 3,100.
That being said, with the exception of the estimate update, not much else has changed for Calvasina. “We continue to see downside risk to the US equity market in the back half of the year. Valuations are frightening, with one of our models now above Tech bubble highs… Our sentiment work – both corporate and investor – reveals a lack of conviction and our work on institutional investor positioning highlights risk in Nasdaq,” she explained.
As for EPS expectations, Calvasina argues “U.S. equities look highly expensive again on 2020 and 2021 EPS.” Offering additional explanation, she stated, “While we acknowledge that Fed stimulus has inflated P/E multiples and is likely to continue supporting lofty levels, the expansion already seen is already on par with what we’ve seen in most prior QE periods. The thing that concerns us the most on the valuation front, however, is that our bottom up combo model is now also 1.9 standard deviations above its LT average, above the 1.5 reading seen at the end of 2019, a little above the Tech bubble high and in a range consistent with modest single digit declines in the S&P 500 over the next 12 months.”
It should be noted that seasonality also represents a significant obstacle, with the months of August and September typically seeing stocks slip. In addition, this timing could “sync up with the looming U.S. election as a negative catalyst,” in Calvasina’s opinion. A rotation into non-U.S. equities, specifically back into Europe where COVID has less of a chokehold, could present another risk.
The bottom line for investors? Due to the potential choppiness in the second half of 2020, Calvasina recommends defensives, secular growers and cyclicals, although exposure to these sectors should be balanced. “Utilities remains our favorite defensive, Health Care remains our favorite secular grower, and Industrials remains our favorite cyclical. Valuations in all three are deeply compelling relative to the S&P 500 on FY2 P/E. None have red flags on ESG (in fact, Utilities and Industrials both tend to be overweighted by ESG funds),” the strategist commented.
But how will the upcoming U.S. presidential election impact the outlook for these sectors? According to Calvasina, a win for former Vice President Joe Biden would be a win for Utilities, given that the space wouldn’t be subject to an increase in corporate taxes. Additionally, as healthcare reform isn’t at the top of Biden’s to-do list, the risk here is lower than for other areas of the market.
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