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Has the US stock market left planet Earth?

10 Sep 2021 1 month(s) ago

Over a fifth of Australian super funds' assets are in overseas stock markets, mainly in the US. American shares have been booming, but where are they headed?

“Predictions are difficult, especially of the future.” So said someone – perhaps the American baseballer Yogi Berra, perhaps not. The business of financial analysts is to make predictions and of course they routinely get it wrong.

Citigroup is feeling a little sheepish about its predictions for the American market in 2021. It was expected to be weaker; it has not been.

“Admitting to mistakes is hard but reviewing errors hopefully allows one to learn and avoid the same issues in the future.”

Well, yes, but it doesn’t make predictions any easier to make. It perhaps feels good for the conscience. Now for the mea culpa:

“The two significant ones we made thus far into 2021 have been the powerful earnings that surprised most on the Street and the second is how effective the Fed has been in pushing investors towards risk assets including more than $500 billion into equity funds.”

The tactics of stock pickers are then revealed:

“Many years ago, a wizened colleague told us that being bullish and right gets accolades, bullish and wrong garners forgiveness while a bearish stance with appropriate outcomes may earn respect on Wall Street, but caution that proves to be wrong can cost one a career. Nevertheless, we feel compelled to stand by our analytical process.”

OK, fair enough. But that is why stock pickers tend to incline towards optimism. If it doesn’t work you can always say the stock will bounce back. But if you pick a fall and it doesn’t happen investors get angry because they felt they missed out. It is why positive recommendations should always be treated with caution.

In any event, there is still reason to be cautious about US equities, says Citi.

“Panic/Euphoria is still worrisome and valuation is problematic even if you consider lower inflation levels. Earnings have been great with estimates climbing all this year and the market sniffed it out, discounting things nine months in advance, In this context, the S&P 500 is up 20% this year (well ahead of our thoughts at the beginning of 2021), almost in lockstep with a similar percentage magnitude of better EPS (earnings per share) trend, and thus fully understandable.

Citi is suggesting that things might slow as the Fed stops printing money that ends up in the stock market (slowing down the money printing is called 'tapering').

“With tapering on the come and EPS (earnings per share) trends poised to slow, we suspect that these items may not be drivers going forward and other factors including euphoric sentiment and stretched valuation become more impactful, offset to some degree by reinvigorated share repurchase programs. In our minds, the stock market needs to consolidate the past 18 months’ worth of gains and portfolio managers require more visibility into 2022 profits, particularly when facing the probability of higher corporate tax rates next year.”

There is little doubt that the FED has been printing money to buy up assets with its ears pinned back, and that has helped the stock market:

But the party may be coming to an end. Citi is still cautious, and with good reason. But what happens to the market remains an impenetrable question, especially when profits (earnings) are doing suprisingly well.

“Bottom-up 2021 consensus (earnings) estimates started the year at $167 and now sit above $200. The investment community appropriately was anticipating a very strong 2Q21 due to easy comps from pandemic- related shutdowns in 2020, but 1Q results beat forecasts by nearly $10 and 2Q came in about $9 above higher expectations. Hence, the S&P 500 has climbed roughly 20% tear to date, commensurate with the revised (stronger) bottom line projections as few clients see the P/E (price earnings) ratio or price/sales metric as looking attractive.”

Citi says FOMO (fear of missing out) sentiment is growing. “In many respects, chasing the tape captures sentiment well as greed is a powerful driver. We find it difficult to abandon our Panic/Euphoria Model given its impressive past predictive capabilities.”

They see overconfidence amongst fund managers.

“We fully recognize that the market is 10%+ above our year-end target and even exceeds our mid-2022 outlook at this juncture, but capitulating against our disciplines seems incongruous. If our numbers are too low for next year, 20x price earnings ratios still are unsustainable in our view even if inflation is not rampant.”

That is called sticking to your guns, which is fair enough.


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