Andrew Pyle
September 11, 2021
New desk, same commitment
It’s hard to believe that it has been thirty years since I started writing these weekly commentaries. They were penned under different titles and different firms, but today, it is truly exciting to be able to talk with all of you from the Pyle Group’s new home at CIBC Wood Gundy. We are blessed to have the most amazing clients and friends that we have the had the pleasure of advising and thankful for all of you that have placed your trust in us under our new banner. This transition was not one that the team took lightly and it was born from a never ending commitment to always searching for the best wealth management experience that can be provided for clients. Our dual mandate of providing disciplined portfolio management and comprehensive financial planning remains and, with our new partners, is only going to be strengthened.
A disciplined approach to the markets is definitely called for as we move out of the summer doldrums. Coming off last Friday’s weaker than expected US jobs report, conviction among equity bulls as certainly has diminished. Actually, there hasn’t been a lot of conviction for a while. At present, the S&P500 is down more than a percent in the first few trading sessions of this holiday-shortened week, which is the worst start to a month in a while. This follows two months where the US benchmark gained only 1.2% per month, after a near flat performance in June.
Bulls will argue that this is quite impressive after the surge in valuations during the first half of the year and that the pullback seen this week is still just a tenth of what would normally be expected after such a run. Earnings growth has been stellar, despite ongoing bottlenecks in global supply chains and is expected to remain strong going into 2022. Bond yields remain low, thus inflating the present value of future earnings – one of the key determinants of a company’s share price. If, after a 20% run, this isn’t much of a setback, right?
It is an interesting juncture to be sure. Due to stronger earnings performance than would be reasonably expected amidst continued concerns over the coronavirus, supply constraints, and continued under employment, analysts and strategists are finding they have to lift their targets. Take, for example, the latest revision by a bulge bracket US investment house, which now puts the S&P at 4250 (more than a 400 point upward revision from its earlier call). Hold on, you say – isn’t the S&P currently just off 4500? If this house is correct, wouldn’t that mean a net 5% drop for the index between now and New Year’s Eve? Of course, had the firm not revised up its forecast it would be implicitly forecasting more than a 15% drop in the index by year-end.
Yet, in either forecast, there is a loss – at least in terms of one company’s forecast. We can also find more bullish strategists that see a 5000 print for the S&P by year-end, which would represent more than a 10% extended rally from today. What I believe we will see will be a blend of these two forecasts. As I have commented before, the market is primed for more than just a 1-2% slip and that sets us up for a more meaningful pullback of 5-10% in the coming weeks. Throw in a 10% rebound from a 5% retracement and you still end up close to 4700 by year-end.
Not to sound like a broken record, but the ultimate spoiler to the party will be higher interest rates as accommodative monetary policy is replaced with neutrality and then tightening. The near-term spoiler though still comes from the virus. The difference between today and the end of 2020 is that the wave of covid-19 cases was seen as cresting in the wake of vaccine rollouts, never to wash ashore again. The stats this summer have put that view to the test and then some. Considering how low the case count reached in June, compared to the relative move in 2020, the recent spike is something that cannot be dismissed.
Studies out of Africa this week painted a grim picture in terms of an ongoing evolution of the virus in on a continent where less than 5% of the population is vaccinated. Considering the length of time that it would take to get even half the population vaccinated, the studies point to an increasing likelihood that new strains will continue to emerge. The risk is that one or more of these strains will render current vaccines ineffective in terms of ending the pandemic, leading to a reinstatement of economic restrictions.
That is still considered a tail risk by analysts, similar to the probability attached to a significant back-up in bond yields. The 10yr benchmark remains half a percentage point below highs seen in the first half near 1.8% and a return to 3% plus levels is a street call that is quite lonely. It is normal for investors to hear talk about lockdowns, runaway inflation and soaring borrowing costs and come away with a magnified sense of concern. The perception is that these things, after a strong run of gains for the market, will bring the party to a screeching halt and carve massive chunks out of one’s portfolio.
The reality is the things that would produce such a correction in the very near term carry a relatively small probability; however, to the extent that equities do drive higher in an environment where conviction is declining, it might be time to re-evaluate risk exposure. That doesn’t mean we should sell the whole enchilada, but perhaps consider trimming back the husk a bit.