It seems stocks are going in just one direction these days—up. Major U.S. stock indexes closed at or near record highs on Tuesday extending a bull rally that has seen the S&P 500, the Dow Jones Industrial Average and Nasdaq Composite indexes surge 75.8%, 69.7% and 104.8%, respectively, since March 23 lows last year. As of Tuesday, the S&P 500 had a trailing twelve month price-earnings ratio of 40.04 – the highest level since October 2009. The extraordinary jump in equity prices in less than a year – during a period of economic distress amidst a global pandemic – has raised worries in some corners that the market is overvalued and due for a correction.
Eight market experts predict the likelihood of a correction and identify sectors and stocks likely to be hurt in the downturn, and contrarily, which sectors would be buoyed further by a continued rally.
Stocks keep rising but how much longer will the rally last?
© 2019 Bloomberg Finance LPMarket Correction Or Further Gains?
Luke Lloyd, investment strategist at Strategic Wealth Partners in Independence, Ohio, which manages $500 million in assets, expects the stock market to “melt up higher.” “When the stock market is at all-time highs, history has shown us that it’s likely to continue higher,” he says. “If a pullback does happen in the near future, I don’t expect it to be a large one or last very long. There are still record levels of cash on the sidelines — right now, there are many people who regret being in cash over the past 6-9 months and want back into the stock market. Any kind of dips in the market will be bought quickly and with force.”
Laila Pence, president of Pence Wealth Management in Newport Beach, Cal., which manages $1.6 billion in assets, does not expect a “substantial, long lasting correction because market dynamics have changed over the last year,” citing that “there is no real alternative to equities at present and a ton of new buyers.”
Pence indicates that more than 10 million new brokerage accounts were opened in 2020, according to investment bank JMP Securities. Indeed, Pence also cites that Holger Schmieding, chief economist at Berenberg Bank in London, recently told the Wall Street Journal: “Americans saved $1.4 trillion in the first three quarters of 2020, or about twice as much as in the same period of the prior year.” Moreover, Pence says more disposable income may arrive in the form of new stimulus checks from President Joe Biden.
Andrew Smith, chief investment strategist at Dallas-based Delos Capital Advisors, which manages $102 million in assets, sees “a low probability” of a stock market correction. “Although the stock market is trading at all time highs, corrections tend to occur during periods of low liquidity and this is not the case today as the Federal Reserve has unleashed unprecedented amounts of monetary stimulus in response to the Covid-19 crisis,” he notes.
But David Rosenberg, president of Rosenberg Research and Associates, an economic consulting firm based in Toronto, is more bearish and says he expects a market correction most likely in the second half of the year, noting that valuations are now “in the top 1% strata of all time.” “When we do get the next [correction], either via a run-up in bond yields, earnings disappointments, [or] delays in achieving herd immunity… I sense that the valuation support is so weak and the Fed so spent, that the drawdown could be akin to what we saw in late 2018 [when the DJIA and S&P 500 dropped about 10% and 14%, respectively, from mid-September through year-end].”
Rosenberg adds that a correction could be sparked by “disappointment over the extent of what the stimulus actually does for the economy as much of it will get saved for the next rainy day and there is a risk that herd immunity comes later in the year or even in 2022.” That, he says, will “thwart efforts to completely reopen the economy and there is a risk that lofty economic and earnings expectations come down.”
So what’s driving stocks up while much of the economy struggles and the real unemployment rate reaches 10 percent? Most observers attribute the nearly year-long rally to trillions of dollars in stimulus measures supplied by the federal government and liquidity provided by the Federal Reserve through bond buying and keeping interest rates at record lows. “There has been a 27% increase year-over-year in the money supply in the economy and that money is looking for a new home,” Lloyd says. “With interest rates low and remaining low for the foreseeable future, that money has found a home in the stock market. The federal government providing stimulus has and will continue to support the stock market as well. More money in people’s pockets means more spending.”
Many experts say Biden’s $1.9 trillion stimulus package – if approved – will not matter much, since the market has already priced in its passage.
“If we don’t get a large stimulus package, we could see a small pullback in the stock market, but I find that very unlikely,” Lloyd notes. “With Democrats controlling the House of Representatives, Senate and [White House], the likelihood of multiple stimulus packages over the next four years is high. The market will like any additional stimulus in the short-term.
Lloyd specifically cites stocks like Amazon, which would benefit with “more money in people’s pockets and [more people] ordering online,” while discount retailers like Walmart would also benefit, as “people are still very price-conscious.” He also likes discount retail store chain Ollie’s Bargain Outlet as “people are out there shopping for deals.”
“Cash in the hands of consumers through stimulus checks combined with enhanced unemployment [benefits] means higher consumer spending or more money for investment – [while] fixed income both carries risk and pays nothing [in yield],” Pence adds. She notes that a new round of stimulus will increase consumer spending thereby encouraging “further growth in e-commerce as well as supporting automakers.
John Stoltzfus, chief investment strategist at New York-based Oppenheimer Asset Management, which manages $34.8 billion in assets, says stocks in the consumer discretionary, information technology and financials sectors will be well positioned to benefit from more federal stimulus. “Industrials… may gain favor as the market anticipates another push for stimulus in the months ahead for infrastructure spending,” he says. “In the nearer term the industrial sector (which is heavily exposed to aerospace and energy) could benefit on [the] anticipation of increased demand for leisure travel [along] with increased demand for jet engine parts, etc. and increased demand for energy products as the economy gains traction.”
Philip S. Blancato, CEO of Ladenburg Thalmann Asset Management in New York, which manages $3.5 billion in assets, thinks consumer discretionary and technology stocks should benefit from a new stimulus package. “Consumer spending comprises 70% of GDP and consumer-focused industries are critical components of the U.S. economy,” he says. “Putting more money in consumer’s hands should have a positive impact on consumer-focused companies. With that in mind, we think companies like Amazon and Apple stand to benefit.”
Andrew Graham, managing partner at Jackson Square Capital in San Francisco, which manages $310 million in assets, says more stimulus will benefit cyclical sectors like industrials and “value” sectors like financials, materials and energy. “Our favorite stocks within financials include First Republic Bank, SVB Financial, Huntington Bancshares, Signature Bank and JPMorgan,” he adds.
What Sectors Will Be Vulnerable If The Market Drops?
In the case of a major market correction this year, Lloyd thinks consumer discretionary names among restaurants, brick-and-mortar retailers, travel and hotels — many of which are richly valued — could decline as businesses in “many states are still shut down and people are more price conscious.”
Lloyd further points out that the tech and healthcare sectors have weathered the storm over the past year as they have improved their earnings and are growing faster than ever. “I would stick with being overweight tech and healthcare for 2021 and I think most dips that occur in these sectors will be bought so you have to be quick on your feet,” Lloyd adds.
In the event of a correction, Pence says, high flying IPO stocks are the most likely to drop the most. “The market in 2019 was characterized by investors shunning IPOs that were unprofitable yet highly valued — evidenced by both the Uber and Lyft IPOs,” she says. “The market has completely shifted its tone over the last year, with the average first day return [of IPOs] at 41%, and a drop in sentiment could hit that segment [of the market] particularly hard.”
Brian Vendig, president of MJP Wealth Advisors in Westport, Conn., which has $702 million of assets under management, says the consumer staples and utilities sectors are at risk of correction over the long-term as the global economic recovery plays out and long-term interest rates increase, causing investors to “shift capital away from these sectors and instead allocate more money to bonds that offer the same types of returns, but with less risk.
Stoltzfus says if the economic reopening becomes severely challenged by mutant viruses the cyclical sectors could likely give back some of their gains until science could find a vaccine of efficacy to respond. “So far however, the vaccine makers appear fairly confident that they will be able to model a response to the mutants in similar fashion to their successful efforts thus far in dealing with the Covid-19 pandemic,” he assures.
But Blancato is more wary of Biden’s stimulus impact, saying that in order for the market “to grind higher we need economic improvement, which will [only] come with the containment of the virus and the ability to reopen the economy to a greater extent.”
Inflation is another long-term concern for investors. “With the additional money supply in the economy and low interest rates, inflation is definitely concerning and could be a silent killer to spending power and portfolios,” Lloyd says. “If inflation runs hot, the Federal Reserve would be forced to raise interest rates, which could derail stock market momentum, along with [posing an] increase in the cost of borrowing both for individuals and corporations. This is definitely a risk I foresee [five to ten] years out.”
