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What’s ahead for the all-time high stock market?: Morning Brief

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Monday, March 29, 2021

Wall Street pros see gains, but modest gains

With the S&P 500 (^GSPC) closing at an all-time high on Friday and the first quarter coming to a close this week, investors and traders are asking where the stock market is headed next. Though, when are they not?

Overall, the tone on Wall Street is a modestly bullish one thanks to bullish expectations for the economy.

At Barclays, the message is simple: stocks look better than bonds.

“Stay overweight equities, given the earnings outlook,” Barclays Ajay Rajadhyaksha recommended on Thursday. “Yes, equity multiples have expanded over the past year, but much of the rally has been due to the absolutely stunning recovery in earnings.”

Elevated valuations is probably the biggest source of consternation for investors. But Rajadhyaksha isn’t alone in arguing that expectations for robust earnings growth and more upward revisions from analysts are why valuations appear overstated today.

“Consider the S&P 500, where consensus in the aftermath of COVID-19 was that earnings would not reach 2019 levels until at least late 2021,” Rajadhyaksha said. “In reality, S&P earnings in Q4 2020 ended up being higher than in Q4 2019; a complete V-shaped earnings recovery within a year despite the backdrop of continued pandemic-related restrictions, and with the wider economy still in worse shape.

“What does this mean for valuations? Equity market valuations based on forward-looking earnings metrics do look elevated relative to history. However, the scale of positive news expected in coming quarters means that stocks still don’t look too expensive to us.”

All that said, Barclays sees limited upside in the near term. The firm has a 4,000 year-end target for the S&P, which suggests less than a 1% gain from Friday’s close.

Meanwhile at RBC Capital Markets, U.S. stocks are looking increasingly attractive due to uneven global progress in the COVID pandemic.

“We are shifting to a neutral stance on U.S. equities relative to non-U.S. equities, removing our prior preference for non-U.S. equities — primarily due to a better COVID backdrop in the U.S.,” RBC Capital Market’s Lori Calvasina said on Wednesday. “While there are some indications over the past few days that new cases in the U.S. may be entering a plateau, igniting worries about another wave in the U.S., they have fallen sharply in the U.S. over the last few months while new cases (and lockdowns) have been on the rise in Europe. At the same time, economic growth forecasts for the U.S. have been moving up sharply, while those for Europe have been falling.”

Calvasina sees the S&P 500 climbing to 4,100 by year-end, with the possibility of getting as high as 4,600 should the circumstances of her bull case scenarios be met.

A dip before more gains?

Deutsche Bank strategists, too, expect the S&P to head to 4,100. But they warn it may not be a smooth ride higher.

“Though we expect equities to continue to move up near-term, we then expect a pullback as growth peaks in Q2 at a high level,” the firm said in a presentation on Wednesday.

Some expect that dip could come in the next few days as portfolio managers rebalance their portfolios as the quarter ends. Since stock prices are up and bond prices are down year-to-date, the thinking is managers may sell some stock and buy some bonds to get back to their target allocations.

But not all pros think this.

JPMorgan quantitative strategist Marko Kolanovic notes that rebalancing doesn’t happen just at the end of the month, which challenges the idea that portfolio managers will dump stocks this week because prices are up in the quarter.

“Multi-asset portfolios with fixed target weights can rebalance monthly, quarterly, based on specific weight triggers, and increasingly are done with discretion/opportunistically (e.g., few days after month-end as we saw last year),” Kolanovic wrote on Thursday. “In addition, increasing numbers of portfolios rebalance based on volatility targets, which often results in flow opposite to those of fixed weights. When looking at how many portfolios rebalance using monthly fixed weights vs. quarterly fixed (based on their impact on market), we find that fixed weight monthly rebalances are prevalent, while quarter-end rebalances effectively lost meaning and actually result in opposite flows (likely due to volatility target contributions to quarterly rebalance).”

Kolanovic gets into the weeds a bit to explain this, and ultimately concludes “there is no expected negative impact on equities from month-end.”

In fact, he takes an even more contrarian view.

“Given broad advertising of some ‘massive month-end selling,’ we caution investors that the impact on the market may be positive with a near-term upside move.”

All that said, it can be treacherous to make big bets on what may happen in the short-term. You never know when some unexpected market rocking event emerges like a single ship running aground disrupting global trade or a big hedge fund liquidating causing all sorts of dislocations in the market.

By Sam Ro, managing editor. Follow him at @SamRo

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