I Call Them As I See Them
I can’t say I was surprised when the market corrected in March. I had been anticipating a market correction for nearly a year, and my target for the S&P (SPY) had always been near the 2,400 level, but I was surprised at just how fast it happened. The COVID-19 pandemic came on so fast, it sparked a panicked re-valuation of the market that left it oversold and grossly undervalued.
When the rebound started, the problem was figuring out what exactly the market was worth in the post-pandemic environment. Bottom-picking soon became earnest buying as conditions evolved into what can only be described as a “melt-up”. Now, with the market on the cusp of the second-quarter earnings season – the quarter hit hardest by the pandemic – the market is also on the cusp of hitting its previous all-time high at least.
The Melt-Up Is Still Happening
A market melt-up is when rapidly improving sentiment fuels a rally. In this case, it’s a combination of factors, including: 1) the pandemic wasn’t as bad as first feared; 2) the rebound got started earlier than many had expected; and 3) the economic data has been good (relatively speaking, in the post-pandemic rebound-watching kind of way).
The problem for many investors is that they didn’t buy into the rebound, and no wonder. There was so much uncertainty in the air, it was only right to expect another correction. That has left lots of people sitting on the sidelines. According to a report in the Wall Street Journal, investors are sitting on a record pile of cash. That’s a lot of money to fuel the rally once the average investor realizes this rebound is more than just a dead cat bounce.
The Data Has Been Really Good
I’ll start with the Initial Claims data, which is improving but still not that great. At just over 1.1 million news claims last week, the figure is still five times higher than the two-year average leading into the pandemic. That said, the NFP last month showed a fabulous improvement in the hiring picture that is backed up by the Challenger report and housing data.
The Challenger, Gray & Christmas report on planned layoffs also tracks planned hiring, and this is one good year for hiring. According to their data, plans for new hires are tracking at 1.25 million year to date and have already set a record high for the year. I can only imagine what the rest of the year will bring. As a point of reference, the bulk of the hiring was done in March and April of the year, so whatever forces were driving the NFP gains were unrelated to the Challenger data.
The Flash PMI readings from Markit are also promising. Both the services and manufacturing PMI readings surged from April to May as the rebound got underway. At 49.6 (manufacturing) and 46.7 (services), it looks like the pandemic driven contraction is coming to an end. Looking forward, I expect to see both figures post potentially record-setting advances next month.
The housing data is noteworthy, specifically the single-family Building Permits, Housing Starts, and New Home Sales Data. The new homes starts and the housing starts figures, in general, were weak in May but at least show an end to the slowdown. Looking to the more forward-looking data, the permits jumped 11% from the previous year and halved the YOY loss. Add to this the New Home Sales, NAHB index, and low levels of new/used inventory and the signs point to a robust rebound in housing this year. Nowish, even.
NAHB Housing Market Index
I think the homebuilders are going to start a ripple effect that will help support economic activity into the end of the year and beyond. The homebuilders laid off a lot of workers and stopped buying land when the pandemic struck – all that will have to be restarted. Not only will there be a boost in hiring activity among the builders, but the effect will also be felt throughout the supply chain and in virtually every community in America.
The Earnings Outlook Only Gets Better From Here
Granted, the coming earnings cycle is not going to be a good one, but there are a number of positive takeaways investors should consider. The first is that this is the bottom. The second quarter is going to be the worst-hit in terms of activity, revenue, and earnings. From here, the picture only gets better despite an outlook for negative earnings growth.
What the market is focused on is this: sequential quarter-to-quarter growth will return next quarter and accelerate beyond year-end. Looking to next year, sequential quarter-to-quarter growth will continue and the market will return to year-over-year growth as well.
Author’s own work, data sourced from Factset Insight
Bringing things back around to the data, with the data stronger than expected and sooner than expected, we can expect the same from corporate earnings. That means upward revisions to the forward outlook, and if there is one thing I value as a market catalyst more than anything else, it’s when the trajectory of earnings growth is positive and the analysts are raising their targets.
Technical Outlook: A V-Shaped Recovery Is In Play
I’ll be honest, I didn’t put much faith in predictions for a V-shaped recovery, and yet, here we have one. The S&P 500 has rebounded sharply from its post-pandemic low and looks like it could easily move higher. The price action is above key moving averages and previous resistance, the indicators are bullish, and the outlook is positive. With this in mind, a retest of the previous all-time high is the least to expect.
As for targets, the first target is the previous all-time high, but that’s not the only one. The rally off the March lows to the latest peak is roughly 1000 S&P points. Now that the index is consolidating and testing support, a continuation of the rebound could the index up another 1000 points. Looking at the past three years as a major, secular-grade consolidation, a break to new highs would imply a move equal to the magnitude of the consolidation range. That’s also roughly 1000 S&P 500 points.
- My target for the S&P 500, assuming a clean break to new all-time highs, is 4000-4500 within the following 12-18 months.
The risk is two-fold. On the one hand, earnings may not be as good as I think they could be. Not to say that -40% EPS growth is good, but there is a chance for better-than-expected results and improvement to the full-year guidance/outlook. On the other, COVID-19 is spreading again. The reopening isn’t going as well as some had hoped, and there could be another round of economic shutdown. If that happens, all bets are off.
The Stage Is Set For A New All-Time High
The stage is set for a new all-time high and more for the S&P 500. The market is in a massive melt-up, there are record levels of cash on the sidelines, the outlook for economic improvement is robust, the trajectory of earnings growth is positive, and there is a possibility for upward revisions. Bottom line, when the market dips, I am a buyer. But only high-quality stocks insulated or boosted by the pandemic and that pay a dividend.
With explosive earnings growth becoming ever elusive in today’s market I expect dividend growth stocks will outperform the broad market over the next few years.
Are you positioned to profit from the capital gains and ever-increasing Yield on Investment provided by dividend growth stocks?
At the Technical Investor, I dig deep into the market looking for the sectors and stocks best positioned to deliver the earnings and dividend growth it takes to drive double-digit capital returns.
Disclosure: I am/we are long SPY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Originally published on Seeking Alpha