Broker Check

Stocks’ Spring Rise in Sight

| April 26, 2021
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As a country, many of us are anticipating the COVID-19 pandemic’s end. We're ready to travel, dine out, see movies, and hang out with friends.  

Some places already act as if the pandemic is over. Of course, it’s not. Cases still exist. However, the combination of treatments and behavior have enabled us to better handle COVID-19, and for the fully vaccinated, almost eliminate it completely. That is tremendous news, and it’s occurring at the same time as the clouds literally part and sunny skies await.

What does this have to do with money? Well, stocks are setting up nicely for a spring awakening too.

A Migration to Quality

After the volatility of February and March, stocks have settled down significantly in April, so much so that volumes are eerily low, even as indexes rose. But as readers of this blog know, market leadership is always important (i.e., which stocks are leading the way).

Suddenly, our data show buying in great growth stocks. These are quality stocks with growing sales, earnings, and profits. It’s almost a reversal to the fundamental norms, after last year's unpredictable market.

Typically, growth is concentrated in technology, healthcare, and some other “stealth tech” areas. But last week we saw discreet buying in MAPSignals’ trusty Big Money Index (BMI), a gauge of institutional investor activity, that was relatively balanced across several sectors:

Digging a little deeper, there were 373 “big money” signals last week, 296 of which were buys. But to get even more granular, 85% of those buys were stocks with solid one-year earnings growth. Additionally, most buys (56%) were of firms with one-year earnings growth of 10% or more – and 80% of those “strong” buys had good or great future profitability prospects.

This all reveals a sudden demand for quality. Interestingly, the inverse is also true – lower-quality names are being ignored or sold.

A good example would be the massive reversal in the investing world’s latest craze – special purpose acquisition companies or SPACs, which are created solely to buy other firms and take them public. Not too long ago, SPAC sales were flying. Now there’s a selloff, which isn’t helped by recent Securities and Exchange Commission scrutiny.

Overall, this run to quality is healthy for the market. Investors are focused on buying excellence and strength, which provides a solid foundation for a future market rally. That alone is historically a great setup, but there's another catalyst just arriving. We’ve talked about it before – the blockbuster earnings season.

Even with the bar being low for this earnings season, our next two or three seasons should also be lights out. Pent up demand, government stimulus, and infrastructure spending should jolt the economy to extreme levels. This will help earnings to stay strong and continue to beat expectations.

Additionally, the BMI is quietly on the rise. After a fall from its peak in February, it bottomed on the last day of March. Since then, it's been rising an average a 0.5% per day, or about 2.5% per week:

Remember, the BMI examines large trading. The reason it is rising quietly right now is because volumes are low:

But when earnings pick up, so do volumes (usually).

So, let's summarize. Volumes are low. Indexes are rising, but there's quality buying on the surface. Unprofitable names are being sold while good growth names are getting all the love. That should juice stocks and their volumes as first quarter earnings beat year-over-year comparisons.

These are all signals that we’re about to lift off. That’s likely why economists are practically tripping over themselves to boost economic growth estimates.

And Now Our Turn

And now we at Cornerstone would like to take some time to trip over ourselves to upgrade our 2021 market prediction!

By Thanksgiving 2020, even though the U.S. economy was still producing less than it had pre-pandemic, the stock market had fully recovered and gone to new highs. At the beginning of December with the S&P 500 at 3,638, we set our 2021 year-end target for the index at about 4,200, which would be about a 15.4% gain.

As of the close of trading on April 16, the S&P 500 was at 4,185, only 0.4% below our year-end target with more than eight months to go. Several factors brought us to this situation. And of course, hindsight is 20-20.

Technology helped the world adjust to shutdowns. Big box stores stayed open. The government disbursed trillions of dollars. A vaccine was invented in less than a year. The money supply exploded as the Federal Reserve cut short-term interest rates basically to 0%.

Accordingly, profits have soared, with real gross domestic product (GDP) growth of 6% or more expected this year and S&P 500 earnings expected to grow by 27% or more. We think stocks will now bust through our original year-end target, and so we're raising our year-end S&P 500 estimate to 4,500, which is about another 7.5% higher than where it is now.

Some investors and analysts are skittish about further gains in equities. But companies have adapted and expanded more rapidly than they would have otherwise. Technology enabled immense gains, which were brought on faster because of the pandemic acting as a catalyst. Plus, persistently low interest rates that are likely to stay low for years make higher price-to-equity ratios more sustainable.

As always, we rely on a capitalized profits model for our fair market value predictions. To review, this model takes the government's measure of economy-wide profits from GDP reports and discounts by the 10-year Treasury note yield to calculate fair value.

If we use the current yield of about 1.6%, the S&P 500 is still substantially undervalued. Even if we only use last year’s fourth quarter profits (and not the expected blowout first quarter profits from this year), it will take a 10-year yield of about 2.4% for our model to show the stock market trading at fair value. Keep in mind, that assumes no further growth in profits, which seems unlikely. That's why we're comfortable upping our year-end target to 4,500 for the S&P 500.

Everyone knows the market won’t move in a straight line and a correction or two is always possible throughout the year. Still, as the economy opens up, the market sectors that fell behind in the past year will be an additional source of strength for equities overall.

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.

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