The currently ebullient macro and stock market environment likely will give way to a period of slower, yet still robust, economic and earnings growth powerful enough to prolong the bull market. However, unease over U.S. Federal Reserve policy and an inflation scare may keep equities range-bound near term.
In other words, investors awaiting a market pullback will be vindicated, eventually, but no one can know when.
The outlook for U.S. stocks, with support derived from improved economic conditions and expected corporate earnings growth in coming years, is optimistic. Government support has been a large driver of global recovery, but underlying organic growth drivers are robust as well.
Strong job creation, increasing hours worked and wage gains should all support healthy income growth as stimulus wanes. Combined with excess savings and higher net worth, the consumption outlook remains robust and is underappreciated in economic and earnings growth estimates.
WASHINGTON – JANUARY 22: The Federal Reserve building is seen January 22, 2008 in Washington, DC. … [+]
With continued uncertainty over inflation, the Fed and COVID-19 variants through the summer, today’s equity market churn could continue. Nonetheless, any setbacks should be viewed as buying opportunities for several reasons.
First, the Conference Board’s Leading Economic Indicator index (LEI) is at levels that historically have been followed by strong returns. Periods following top-decile LEI readings –including our current environment – witnessed the S&P 500 rally 7.5%, on average, over the subsequent six months. May’s latest print edged slightly lower than April’s, but LEI activity remained firmly in the top decile at a robust 14.7% growth year-over-year. Seven of the 10 LEI components increased.
Second, an old friend of equity investors has returned: share repurchases. Given the excess cash reserves many U.S. companies have, buybacks appear to be just getting started. Nearly $400 billion have been announced this year by S&P 500 companies. If maintained through 2021, this pace would result in the second-largest amount of repurchases on record, behind 2018, when the Tax Cuts and Jobs Act’s repatriation of overseas earnings led to outsized return of capital to shareholders.
Like corporations, investors are clamoring to purchase equities. According to Bank of America, flows into global equities could reach $1.18 trillion this year. If achieved, this pace would produce more than 1.5 times the total flows into the space during the last 20 years combined!
Valuations are inflated, but stocks may grow into these multiples given strong economic and earnings growth and low interest rates. In the last cycle, when growth and rates were anemic, investors directed their capital away from equities and into bonds.
The relative success of vaccination campaigns is causing countries to emerge from the COVID-19 pandemic at different points, but global household balance sheets are healthy. Individuals accumulated excess savings due to broad government stimulus and an inability to spend.
Deploying this unprecedented savings should fuel reopenings. Global economic activity may become a relay, with the baton passing from China to the U.S. and then on to Japan, Europe and the U.K.
That baton could pass next to companies, which may be considering their capital expenditures. Capital spending tends to follow higher-than-expected demand as businesses expand to meet perceived needs. U.S. inventory-to-sales ratios are well below pre-pandemic levels and just above 2011’s all-time lows. This suggests a restocking cycle ahead.
Many businesses likely will choose to expand into this period of strength, with robust earnings translating into excess cash that can be reinvested again. Even if consumption begins to ebb, with so many businesses deploying investment capital, economic growth could remain high.
History says buy the dip when it comes. We agree not because we are advocates of market timing – we are not – but because there are many good reasons for U.S. stocks to remain attractive going forward.
Jeffrey Schulze, CFA, is a director and investment strategist at ClearBridge Investments, a subsidiary of Franklin Templeton. His predictions are not intended to be relied upon as a forecast of actual future events or performance or investment advice.
Any information, statement or opinion set forth herein is general in nature, is not directed to or based on the financial situation or needs of any particular investor, and does not constitute, and should not be construed as, investment advice, forecast of future events, a guarantee of future results, or a recommendation with respect to any particular security or investment strategy or type of retirement account. Investors seeking financial advice regarding the appropriateness of investing in any securities or investment strategies should consult their financial professional. Neither ClearBridge Investments, LLC nor its information providers are responsible for any damages or losses arising from any use of this information.
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