This year's 'Big Surprise' could be the bullish consensus wasn't bullish enough
A year of “unprecedenteds” sets stage for an unexpectedly strong move higher in stocks.
As many of you know, I like to start each year sharing what we think will be the big out-of-consensus surprises in the 12 months ahead. But first, full disclosure: last year’s predictions were virtually all wrong except for the outcome, which was an S&P 500 year-end target of 3,500. And even that seemed a bit off the mark as the Covid crisis brought the financial markets to its knees in early spring. In the end though, our bullish call on the secular bull, and the digital forces driving it, was actually strengthened, not weakened, by the Covid storm. The rest is history.
As we examine the outlook for 2021, one element that is scary is that unlike previous years, this year’s consensus is almost universally bullish. So, we’re not alone. Yet, as we examine this consensus and try to sort out where, if at all, we’re different, we find ourselves focusing on five positive surprises that could make that consensus not bullish enough; hence, our outsized S&P call at 4,500 versus a Wall Street consensus around 4,100. And with many investors still holding onto cash hoards built up during the volatile months of last spring, we think there’s plenty of fuel to get us there if we’re right about even just three of our surprises.
Before we get to this year’s surprises, we need to remind ourselves of the five historic firsts that not only made 2020 so memorable, but also laid the foundation for the strong market we see ahead:
Five aspects of 2020 that were historic and set the backdrop for an historic 2021:
- The first truly global pandemic in 100 years. What was even more consequential was that it hit the entire world almost at the same time. Rampant air travel and an intertwined global economy carried the novel coronavirus across borders and oceans within days, not months and years as was the case with the Spanish flu in 1918-20, when most of the world got around on horses, railroads and ocean liners.
- Most tightly synchronized global economic shutdown in history. Covid-19’s nearly synchronous arrival spawned similarly simultaneous shutdowns as governments moved to combat the disease. Seemingly overnight, the world was closed for business in late winter/early spring as borders closed, businesses shuttered and shelter-at-home orders swept the globe.
- Largest, quickest market drawdown in history. The S&P plunged 30% in just 22 days off last February’s peak, and 35% on intraday trading, entering a bear market in record time. In fairness, aided by record fiscal stimulus/relief and a “whatever it takes” Fed, markets also scored their quickest emergence from a bear market in history and ultimately closed the year at record highs.
- Largest-ever outperformance of growth vs. value in history. Even with value’s relative outperformance the final three months, growth killed it in 2020 as the pandemic accelerated the digital revolution, taking Big Tech and other growth companies that experienced unexpected demand from a work-from-home world along for the ride. The Russell 3000 Growth Index beat the Russell 3000 Value Index by a record 35.4 percentage points over the course of 2020, with respective cumulative returns of 38.3% and 2.9%.
- Quickest-ever development of a global vaccine in history. This arguably is the most remarkable of last year’s remarkable developments. Biotech and Big Pharma developed at least three highly efficacious Covid-19 vaccines in nine months—a process that typically takes years, often decades.
Now, the five aspects of 2021 that make the optimistic consensus too conservative:
- Most synchronized global economic recovery in history to begin midyear. Though large swaths of the global economy already are moving higher if not booming (think U.S. and Chinese manufacturing sectors, U.S. housing and, of course, all things technology and internet), “animal spirits”—confidence—has yet to fully engage. How can they? Everyone is still “working from home,” even in China, where tourism and travel remain on complete lockdown. Readers of this space know that my favorite syllable in “Economy” is “Con-fidence.” And what many folks are simply underestimating is what happens when, almost on the same day sometime this June, the world is vaccinated and we all feel safe again. When everyone comes out of their Covid caves, their piggy banks stuffed with savings, and decides after the long shut-in to take a well-deserved splurge—at once. This kind of economic event has never happened before in the history of markets. This kind of event is not inside any of the models of your favorite Wall Street economist. News flash: it’s not going to be a negative downward adjustment to their numbers.
- Largest-ever trailing 12-month buildup of fiscal and monetary stimulus. Congress approved $3 trillion of Covid relief and assistance last year, and trillions more seems possible from a Democratic Congress and White House bent on more aid and more spending on infrastructure. Across the pond, the European Union last month approved a $2.1 trillion long-term budget and Covid relief package. Meanwhile, the Fed and other central banks remain all-in, with balance sheets that have ballooned a collective $8 trillion since last March. The cumulative impact of all this stimulus is likely to be hitting the global economy sometime around … late spring. Gulp!
- Largest year-over-year (y/y) earnings recovery in cyclical sectors since 1934? This year’s earnings numbers, particularly in the more cyclical, traditional “value industries” that were almost shut down last year, will make for perhaps the easiest y/y comparisons since the depths of the Great Depression. The consensus on S&P earnings-per-share has been rising and most recently has been coalescing around $170, which would represent more than a 20% increase off last year’s beaten-down number. Our guess is this remains too low, as many bottom-up forecasts hang on house economists’ “reasonable” economic growth forecasts, which are probably unreasonably low. The growth stocks within the markets will themselves grow off last year’s base, albeit at a slower pace. But add to this the impact of many “value names” that were shut in and contributed almost nothing to last year’s market earnings, and you get, we think, a very positive surprise.
- Quickest labor-market recovery in history. While the collapse in the labor market wiped out 21 million jobs in two months, the recovery has been historical, too. May and June alone saw 7 million jobs added, far more and faster than ever before. Nearly 11 million jobs were recovered in eight months and, while those gains slowed as new Covid restrictions kicked in near year-end, we think job growth will reaccelerate into spring and beyond, led by a continuing surge in gig economy jobs and returning hospitality and leisure work as customers come back. Most Wall Street models, based on pre-gig economy datasets, assume big unemployment spikes take years to cure. But the gig economy workers, though lower skilled, are also quicker adapters. Our guess is that by this time next year, “Help Wanted” signs will be the big concern, not unemployment.
- Lowest discount rate on stocks, relative to their visible growth outlook, ever. As we emerge from the Covid crisis, the 10-year Treasury yield is just north of 1% and is likely to drift higher, but a breakout above 1.5% seems unlikely given global demographics and the ever-present central banks. The latter have short rates pinned to the canvas at near zero levels. So risk-free rates are holding at or near historical lows. At the same time, the aforementioned macro and earnings environments argue for significantly higher forward earnings and cash flows. And with the clouds of the crisis behind them, investors will be more inclined to believe in those forward flows and be willing to apply the new structurally lower discount rate to them. When they sit down and do that math, P/E multiples on stocks, which looked high relative to depressed earnings and historic, higher interest-rate levels, will suddenly look way too low. That dichotomy can only be resolved by one thing: stock prices moving higher. Goldilocks.
One last thought, perhaps now a “broken record” but I need to say it again: we are in a once-in-a-generation secular bull market, driven by structural forces that run deep and strong: the digitization revolution, the biotech revolution, the manufacturing renaissance and structurally lower rates. And investors remain cautious with record cash levels. 2021 is a good reminder to all of us that while near-term risks and “black swans” abound, when the current is deep and strong and it’s going up, best not to swim against it. Stay diversified, for sure. And stay overweight stocks. Even a bullish consensus can be wrong; it can be not bullish enough.