Investor sentiment has clearly shifted over the past two weeks as a broad-based equity rally for U.S. markets has taken hold. While anxiety remains high, especially around the elections, big money has been moving into value stocks, small-caps tied to the recovery, and industries that may do well if Biden wins the presidency in November. While the polls may indicate that result with a few weeks to go until November 3, U.S. elections have proven to be unpredictable in recent history.
Corporate earnings, which begin in earnest this week, are likely to show some upside surprises, although many risks remain.
As always, we turn to two top strategists, Katie Koch of Goldman Sachs Asset Management, and Ryan Detrick of LPL Financial for their insights.
While we are sharing strategists' recommendations, every investor needs to make their own decisions based on their risk tolerance and personal situation. The comments herein are for your perspective, but should not be taken as investing advice.
Katie Koch, Co-Head of Fundamental Equity, Goldman Sachs Asset Management
Preparing for Election Volatility by Embracing Green Opportunities
"Ahead of expected market volatility around the US presidential election, we’re working with clients to ensure their portfolios are set-up for success with desired rates of risk and return. As it stands, the traditional 60-40 portfolio benchmarks have declined from their traditional 7-8% annualized rate of real returns to an expected 2-3% projected over the next 10 years, which is why we believe equities will play an important role in making up lost ground. For example, 70% of the S&P 500 is delivering yields above the 10-year Treasury bond. As we evaluate potential opportunities, we continue to focus on green areas of the market across geographies.
As it stands, the market is currently pricing in a Blue Wave, which would facilitate massive infrastructure and green energy investment. However, regardless of the election outcome, we believe that corporations will be the largest investor in clean energy globally and will facilitate a paradigm shift not seen since the industrial revolution – one that has the potential to match the pace of the digital revolution. Around the world, we have seen commitments by Europe and China to be carbon neutral by 2050 and 2060, respectively, signaling a strong and consistent global demand for renewables. In our view, capturing this shift requires an active and thoughtful approach to ESG, as opposed to relying on third-party data and rankings, which are incomplete, inconsistent across providers, and backward-looking."
[The securities listed below are not recommendations from Katie Koch, GSAM or Investopedia. They are for reference and informational purposes only]
Ryan Detrick, LPL Financial Sr. Market Strategist
Earnings Growth is Approaching
This earnings season, corporate America will get closer to the return of earnings growth—which is likely in the first quarter of 2021. We probably will have another decline in profits for third quarter 2020, though potentially only about half as big as last quarter’s. And we will undoubtedly hear more about uncertainty—both COVID-19 and election-related. We also highlight three things investors can watch this earnings season.
Moving in the Right Direction
"How investors evaluate this earnings season will depend on their perspectives. We are likely to get a much smaller year-over-year decline in S&P 500 Index profits in the third quarter compared to the second quarter, which is good news. Consensus is calling for a roughly 20% year-over-year decline in earnings per share (EPS) according to FactSet’s estimate, but we expect quite a bit better.
The consensus estimate for the third quarter has risen by about 4% over the past three months (best such increase in more than two years according to FactSet), a good sign that companies may be able to deliver more than the typical upside. And although fewer companies have offered guidance because of the amount of uncertainty, 67% of the guidance has been positive, significantly higher than the five-year average of 32%. Accordingly, we expect company management teams to instill confidence that the earnings rebound baked into analysts’ forecasts—or at least something close to it—may materialize.
What to Watch
We are watching for three things this earnings season:
- Impact of COVID-19. The increase in analysts’ earnings estimates reflects increased confidence in the outlook, even with the challenges COVID-19 still presents in terms of social distancing, various safety protocols, and shifting consumer behavior. We have been encouraged by recent data pointing to a continued steady reopening of the economy, and we believe the likelihood that additional lockdowns may meaningfully impair business activity remains very low.
- Election front and center. As Election Day approaches, we expect to hear more about how potential policy changes may affect companies, particularly those most sensitive to regulations such as energy, financial services, and healthcare. Questions about regulatory risk for technology companies, as well as digital media and e-commerce, will surely come up on conference calls, so look for updates there. We think fears of large technology company breakups are overdone, while healthcare’s solid earnings outlook is being underappreciated by the market, in our view. We expect earnings growth only in the healthcare, technology, and utilities sectors this quarter, likely in the low single digits across the board.
- Winners will keep carrying us. According to Credit Suisse, 54% of the market capitalization of the S&P 500 is on track to grow earnings in 2020. We believe the chances are good that the technology sector and the digital media and e-commerce internet industry groups will produce earnings growth in the third quarter. As long as those winners keep winning, and we think they will, they provide a solid earnings foundation for the broad market.
Earnings Outlook Intact
Following the strong second quarter earnings season, we raised our 2020 S&P 500 EPS forecast from $120–125 to $125–$130. That higher forecast still represents a drop of more than 20% from 2019 levels, similar to the historical average during recessions. We also believe it reflects both the snapback in economic activity this summer and early fall and the ongoing economic challenges presented by COVID-19.
But stocks are trading on expected earnings for 2021 and beyond, so we would put our focus there. That’s when economic conditions may return to some semblance of normal. Our estimate of normalized earnings, or the amount of earnings S&P 500 companies can generate after the pandemic ends, is $165 per share. The combination of efficiencies gained during the recession (which we think ended a few months ago), the strong performance of the winners, and the tremendous progress in COVID-19 treatment and vaccine development, all suggest we may be only a year away from reaching normalized earnings, though we fully recognize the risk that timeline may end up being too aggressive.
Reiterating our Positive Stock Market Outlook
Our year-end S&P 500 fair value target range is 3,450–3,500, based on a PE ratio of near 21x and our normalized EPS estimate for the S&P 500 of $165, which we believe is achievable beginning in mid-2021. We anticipate further gains for this young bull market as the new economic expansion continues. We acknowledge the election is a wildcard, but history tells us election-driven volatility in the S&P 500 tends to be temporary and often followed by solid gains.
We believe these above-average stock valuations are justified based on the stronger-than-expected economic recovery to date, monetary and fiscal policy stimulus (and we think more is on the way), depressed interest rates and low inflation, and the likelihood that a safe and effective vaccine will be identified by the end of the year. We expect the developing earnings rebound may help stocks grow into their valuations over the rest of this year and in early 2021, as we hopefully see the end to the pandemic."