We expect that the strong economic recovery will continue into the coming year, furthering earnings growth and stock gains. The US stock market has seen explosive growth over the past ~16 months, with the S&P 500 returning approximately +92% since the March 2020 bottom. With that being said, forces like inflation and interest rates may begin to pressure the market as investors become wary of the downsides associated with each.
This is not to say that the market will go into decline. According to LPL Financial, the average S&P 500 gain in the second year of every bull market since 1950 has been around 13%. However, for bull markets that follow declines greater than 30%, the average gain in the second year is 17%, which would put the Index closer to 4,600 (an additional +4.3% upside from current price).
In the second year of a bull market, volatility does tend to come into focus with plenty of small market pullbacks and corrections. These corrections and pullbacks on average range from 5-20%. For example, in 2009, the market had a 17% correction in the second year of its bull market. While these corrections may be something to watch for, they may not be prolonged downturns as the momentum from the reopening and stimulus is working its way through the economy.
After superb earnings in Q1 2021, estimates for future earnings have increased even more than originally expected at the beginning of 2021. Based on the strength of corporate profits, LPL Financial expects S&P 500 earnings per share (EPS) to increase by 36% from 2020. While this projection is above current estimates, it is not out of the question given the strong economic outlook and the positive earnings environment that companies are currently experiencing.
Valuations & Interest Rates
Based on valuation metrics like Price to Earnings (P/E) ratio, valuations are elevated when looking from a historical perspective. However, these valuations begin to look more reasonable when taking into account where interest rates currently are (near zero) and the position the Federal Reserve has taken in regard to increasing rates. At the moment, the consensus projection has the Fed keeping rates where they are until at least late 2022, and likely into 2023.
As we head into the second half of the year, it will be important to stay up to date on what is happening in the global economy and how it is changing. For the first time in a decade, developed international stocks look like they could potentially outperform US stocks as European economies begin to recover and investors begin to push assets back into the asset class. Contrarily, geopolitical and regulatory threats may limit gains for China-heavy Emerging Markets indices. The headline risks currently faced by China & EM are causing many investors to trim their exposures.
All in all, staying aware of changes in global markets and politics can help navigate through new risks and help you down the path to financial freedom. If you have any questions, feel free to reach out.