Given the fierce move by equities in the past few weeks, it is not entirely surprising to see stocks consolidate over the last few days. And not surprisingly, there are more than a few who believe markets have become overly exuberant. To an extent, I understand this. There has been both a sizable move in markets coupled with a sizable rotation into epicenter stocks. However, I still see upside into year end. More on this below.
On the COVID-19 front, daily cases came in at 181,547 on Thursday, and Wave 3 remains on the rise. And although the daily change vs 7D ago, which is the key leading indicator we track, dipped below 20,000 on Wednesday, it jumped again on Thursday to 32,824.
And daily deaths from COVID-19 in wave 3 are now meaningfully higher than the death toll seen in wave 2 and are only 27% below the peaks in Wave 1. Given daily cases are almost four times the magnitude of wave 1 and are a leading indicator of mortalities, we should expect daily deaths from COVID to surge in the coming weeks.
But it is worth mentioning that in just the past few weeks, we have witnessed advances in the treatment and prevention of COVID-19. While we are not yet seeing this in reduced cases or mortality, these collectively should slow the scourge of COVID-19 and eventually stop it in its tracks (vaccine). New treatments like Olumiant, etc also reduce the risk of mortality, so we can be less pessimistic than previously.
STRATEGY: Raising S&P 500 target to 3,800 by year-end (vs 3.525 prior)
This week, I highlighted ten main tailwinds that I see driving P/E expansion which are causing me to raise my 2021 P/E estimate to 19.7X from 18.3X. This translates to an S&P 500 target of 3,800 (based on EPS of $193). Thus, we are revising our YE target up from 3,525 (which we raised on 8/13) which represents about 6.5% upside. For context, this is about the magnitude of a typical Santa Claus rally, so the expectation is that markets see their typical seasonal gains. And form a valuation standpoint, this target P/E of 19.7x is about the same as the high yield implied P/E (inverse yield to worst) of 20.6x.
We have written multiple commentaries about the tailwinds for epicenter stocks, and in particular, how they are the most leveraged to both vaccine/therapeutics (i.e demand recovery) and economic recovery (i.e. operating leverage via cost cutting). And interestingly, while the broad-based S&P 500 index was “treading water” for the greater part of this week, “Epicenter” stocks took the lead in response to the improved healthcare outlook.
During this same period and using the SPHB ETF as a proxy for epicenter stocks, they have risen strongly in that same 9-day period with SPHB rising approximately 15% in that timeframe versus a nearly flat S&P 500.
I continue to see the best risk/reward in the epicenter. However, unlike earlier in 2020, there is much greater visibility and tangibility to a vaccine and cure for COVID-19. Thus, the ability for markets to look beyond contemporaneous cases should be much higher. And interestingly, even though epicenter stocks have outperformed the past two weeks or so, this outperformance has been a fraction of the approximately 7,000bp YTD outperformance of growth stocks and is still weaker than the post wave 1 epicenter rally. Thus, I see substantial upside for epicenter stocks.
Bottom Line: I see upside for equity P/E ratios rising which increases my S&P 500 target to 3,800. I continue to see epicenter stocks as the most attractive risk/reward.
Figure Comparative matrix of risk/reward drivers in 2020
Per FSInsight
Figure: FSInsight Portfolio Strategy Summary – Relative to S&P 500
** Performance is calculated since strategy introduction, 1/10/2019
