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Equity Market Half Yearly Update

We started 2021 with the view this would be a fantastic year for equities. We cited the three legs supporting higher prices as fiscal stimulus, zero interest rates and growing earnings.

The S&P is up 17.5% as at the close of July 23rd and the Australian All Ords is up 12.0%

So far things have been going as forecast. The three legs have been supporting growth stocks as predicted and equities are making new all-time highs.

Let’s take a look at our three major drivers.

Fiscal Stimulus

In March of 2020 the Fed announced they would be buying corporate bonds using its emergency lending powers. The announcement worked almost instantly restoring investor faith in the market and allowing it to function once again.

In June the Fed announced they have ceased the purchases and will begin selling down the $13.7billion they have acquired.

The market took this in stride and the news did not cause any kind of set-back. The corporate bond purchases were one of the more controversial moves of the pandemic and announcing the end was a delicate maneuver. The fact the market didn’t react was very positive for equities.

The Fed’s policy-setting Open Market Committee is also buying huge amounts of government-backed bonds, but those purchases are different, meant to foster stronger economic conditions by keeping markets chugging and holding down borrowing costs.

It is these purchases that make the real difference and the Fed is still making them. They might soon need to do even more if Biden gets his way.

Biden is trying to gain support for a $1Billion infrastructure spending program. He has been flying around trying to convince members of both parties his plan for funding this is sound. If he can eventually get it agreed, there will be even more liquidity injected into an already flooding system.

It could be this leg that drives markets on their next leg higher

Zero Interest Rates

The overnight Fed Funding Rate target is set at zero to 0.25% and we have not seen any change in this. The Fed has said they don’t expect any change until at least 2024.

But recent inflation reports have caused investors to become concerned the Fed might act sooner. Interest rates cause a bigger impact to the growth segment of the market, especially those companies that don’t generate a lot of revenue now, but are forecast to in the future. Rising interest rates have a large impact on discounted future cash flow models.

Every time we see a high inflation number equities have briefly sold off. But these periods do not last long and buying soon resumes. The Fed keeps saying they believe any inflation will be temporary and they only look at long-term impacts.

This battle of predicting inflation is the hot topic for investors.

Our approach is to keep it simple. No one can predict the future, so it is pointless trying.

The Fed is probably the biggest force in the market. You do not want to take a position against them.

They have re-stated how they calculate inflation, giving themselves the ability to ignore short-term inflation prints and have continually told the market they have no intention yet of changing interest rate policy.

Despite the media causing fear in their readers every time inflation is announced, the fact remains the Fed is a long way off raising rates.

Companies and mortgagees can continue to borrow at very low rates, leveraging those funds to create higher asset prices through growth and acquisitions.

This is a major reason we haven’t seen a 5% pullback in stock prices since last October. We aren’t likely to see one any time soon either. If we do, it will just present a good opportunity to add to positions in your favourite growth stocks

Company Earnings

Company profits continue to grow at a record pace. We are in the middle of Q2 earnings reports and so far 83% of companies have exceeded analyst expectations for profits and 81% have exceeded on revenues. To illustrate just how strong this has been, the long-term average for revenue beats is 54%. Usually, analysts get it pretty close to spot on. But presently companies are growing so fast analysts are struggling to get close to the numbers they are generating.

When looking at S&P500 earnings, the 2021 number is predicted to be 37% higher than 2020. 2022 is forecast to add a further 11% on top of 2021.

Corporate America is firing on all cylinders and confidence is also strong. We have seen 17.3% of companies raise their guidance. This compares to a pre-Covid average of 5.1%. Managers are telling us their business is stronger than we think and their companies will be making more profits than previously thought over the coming quarters.

Conclusion

Equities remain in a picture-perfect uptrend channel that has just broken out to new highs supported by the three legs of Fiscal Stimulus, Zero Interest Rates and Rising Earnings.

The only concern is high inflation, but there have been signs we might have already seen peak inflation and we are already heading back to more normal levels. Core inflation gains have been driven overwhelmingly by a few narrow categories.

While there will likely be tailwinds for core PCE inflation from rent in the coming months, and inflation may run above 2% for some time, there’s little reason to worry about runaway price gains given where the recent jolt has come from. This is exactly what the Fed has been telling the market and why they are happy to continue their stimulus measures

Equities never take a straight path higher, but without even a 5% decline in the last 9 months, recent gains have been as straight as we have ever seen.

With all three legs still in place, we see no reason for this to not continue. Our advice remains to stay 100% invested and if you do happen to have any money on the sidelines, take any pullback as an opportunity to add more.

We suspect this year will see a 30% gain for stocks overall. The S&P500 is already up 17% and we will shortly be entering the traditionally strong period of the year. There will be more gains to come in 2021.

Disclaimer: Capital 19 Pty Ltd ABN 17 124 264 366 AFSL 441891 (‘Capital 19’) believes the information contained is reliable, however, no warranty is given as to its accuracy and persons relying on this information do so at their own risk. This communication is for general information only and was prepared for multiple distributions and does not take account of the specific investment objectives of individual recipients and it may not be appropriate in all circumstances. Persons relying on this information should do so considering their specific investment objectives and financial situations. Any person considering action based on this communication must seek individual advice relevant to their circumstances and investment objectives. Subject to any liability which cannot be excluded under the relevant laws. Any opinions or forecasts reflect the judgment and assumptions of Capital 19 and its representatives based on information at the date of publication and may later change without notice. Any projections contained in this presentation are estimates only and may not be realised in the future. The investment manager certifies that all the views expressed in this document accurately reflect their views about the companies and securities referred to in this document and that their remuneration is not directly or indirectly related to the views. Capital 19, its directors, representatives, employees or related parties may have an interest in any of the companies and securities in this document and may earn revenue from the sale or purchase of any financial product referred to in this document or any advice. Past performance is not a reliable indicator of future performance. Unauthorised use, copying, distribution, replication, posting, transmitting, publication, display, or reproduction in whole or in part of the information contained in this document is prohibited without obtaining prior written permission from Capital 19.
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