This edition of Alpha City is a recap of my recent webinar. A replay is available here:
Here are some questions I’ve been getting from clients and my answers:
Is the U.S. equity market disconnected with reality? NO. The ongoing market rise makes sense. The oversold condition on 3/20 was extreme and there have been positive inflections in all our preferred tactical indicators. Earnings revisions have clearly turned less bad — and that’s BULLISH. Investors are valuing the S&P 500 and its constituents on some type of forward normalized earnings, NOT trough profits. We’ve seen unprecedented monetary and fiscal policy and more is likely to come. Continued skepticism by investors, which is a contrarian positive, is helping equites climb the proverbial Wall of Worry. Earnings revisions are driving equities higher
Is the S&P 500 extremely overvalued? NO. Investors should use normalized S&P 500 index SPX EPS not depressed 2020 profits—at least 2021 EPS, and better would be 2022, which I estimate preliminarily $180-200. Fair value forward P/E calculation should include interest rates, inflation, and the policy backdrop. With all these factors near maximum bullish, I could make a strong case that the forward P/E SPX multiple should reach 20x-22x, at minimum. I see a range of 3600 (20 x $180) to 4400 (22 x $200) as achievable over time.
Should investors finally be moving away from our recommended barbell (Growth/FAANG & Value/Cyclicals) positioning? NOT YET, but the time is coming. I advise lower cash levels and raising risk exposure as we look for higher markets 6-12 months into the future. Also, lower weightings in traditional defensive areas of the equity market — Staples, Utilities, Real Estate, and legacy Telecom within Comm Services sector — when they outperform.
Importantly, our work recommends a barbell approach of having some of both Secular Growth/FAANG and Value/Cyclicals while Covid-19 still on the front page. Once we are close to passing pandemic fears (peaking cases and/or definitive vaccine announcement), shift quickly towards Value/Cyclicals and take some profit in Secular Growth/FAANG.
Will the equity markets start evolving from macro/technicals to fundamentals/earnings revisions? YES. Initial bounces tend to do little with operating fundamentals or with single stock idiosyncratic factors, but more to do with behavioral/psychological, fear, greed, technicals, and news releases.
However, as the healing process continues there is a transition as the environment reverts to more fundamental or operating indicators and correlations fall. Thus, be ready to shift from macro, technicals, and headline watching (Beta) back to earnings revisions and our ERM model (Alpha) to help generate returns.