Reviewing where we’re at today, the market has told us that the nightmare of 2020 is almost over. The major forward-looking indexes delivered all-time highs the morning after Thanksgiving Day:
For some perspective, November’s gains in the Dow Jones Industrial Average were the best November the index has seen since 1928, and the best of any month since January 1987. Post-election, the market is clearly painting a picture from a forward-looking perspective that it’s not mired in the current warnings of a dire, COVID-riddled winter.
While we can't promise December will replicate November’s record-breaking ascent, historically December has been one of the best months in stock market history, coming in as the second-best month of the last 50 and 100 years (see chart below). Much of this can be attributed to the “Santa Claus Rally” we’ve mentioned in the past. It arises from overall happier feelings, as well as pensions and other large institutions being required to put capital to work at year’s end.
However, Decembers are often a tale of two halves. It often starts flat, then picks up for the Christmastime rally:
“Tour de Force” Market Cycling Revives the Dead
Looking back to the shortened Thanksgiving trading week, our trusty Map Signals’ Big Money Index (BMI), which provides guidance on what is driving the market growth, showed the continuation of a huge trend that we've written about - the “cyclical catch-up trade.”
It’s alive and well.
Money is being deployed in sectors that were left for dead. And as news of COVID-19 vaccines gains momentum, so do stocks that would benefit from a full economic recovery. More specifically, value and small cap stocks were aggressively gobbled up through November. Unloved sectors like real estate and financials benefited. Shockingly, even energy stocks are starting to get some love, although some of that is from aggressive short covering.
As most everybody is aware, those have been the “weakest of the weak” stocks throughout almost all of 2020, until recently. Per the chart below, a shocking 137 percent of the energy universe was bought up by “big money.” Materials and real estate were the second and third most-bought sectors, respectively.
As we said last week though, don’t get carried away and let recent events cloud what has been working for years. Specifically, technology stocks have propped up this entire market for a long time, and we don't think they are falling out of favor, but rather taking a breather as other stocks catch up.
That said, based off current data, we are expecting the BMI to move into overbought territory in the next week to 10 days, if this trend continues. Still, we should continue to see the market rise higher in the coming weeks, then on towards end of the year, which would support the “Santa Claus Rally” thesis.
But eventually there will be a tipping point where an inevitable market correction happens. This is expected and will likely play a pivotal part in our asset allocation and rebalancing decisions early next year.
So, Will Santa Bring a Good 2021?
As we turn our attention and research towards 2021, we want to provide our initial market expectations. We rely on our research partners’ Capitalized Profits Model, which takes the government's measure of profits from gross domestic product reports and discounts it by the 10-year U.S. Treasury note yield to calculate the market's fair value.
Last week, corporate profits for the third quarter 2020 were reported at a record high, up 3.3 percent from a year ago. Who saw that coming?! So, the question is what discount rate should we use, considering the 10-year Treasury yield is less than 1 percent? Obviously, yields are being artificially held down, but our expectation is the 10-year note will finish 2021 yielding around 1.25-1.50 percent.
Regardless, to be more conservative we've applied a discount rate of 2 percent in the model. Thus, when plugging in third quarter 2020 profits, it creates a fair market value estimate for the S&P 500 of 5,150. As a result, we’re targeting a year-end 2021 reading on the S&P 500 of around 4,200, and of about 35,000 for the Dow. This reflects our belief (and anticipation) that the COVID-19 vaccines being developed by multiple entities around the world will work roughly as advertised in the first half of 2021 and businesses will continue to improve in handling the pandemic and government shutdowns alike.
But remember, ultimately, profits and interest rates drive stocks. Those factors determine our outlook, nothing else. It's just the math. And right now, the math looks good.
Securities sold through CoreCap Investments, LLC. Advisory services offered by CoreCap Advisors, LLC. Cornerstone Financial Services, CoreCap Investments, and CoreCap Advisors are separate and unafﬁliated entities.