The S&P 500 closed Thursday at 4,019.87 at an all-time-high. Despite this, there have been a lot of bears pronouncing the top for any number of reasons. We are encouraged by the ample bearish sentiment that is out there. All-time-highs are all-time-highs. The market speaks in terms of price. We see plenty of bullish catalysts that should drive the market higher from here. Not only are all-time highs great but something that was particularly encouraging about today’s rally is that it was led by Technology and Energy simultaneously. This has been rather anomalous compared to the market dynamic over the past few weeks. Vaccine penetration continues to be ahead of schedule and the prospect of the healthcare system being overwhelmed, the reason for commerce-interrupting lockdowns diminishes by the hour with each jab administered.
My colleague Tom Lee spoke about how institutions have been raising cash. Dry powder is accumulating to power the next leg higher. We think the S&P 500 hits 4,300 in 1H2021. ISM numbers today and other data from not only the United States but around the world continue to suggest an unprecedented economic boom, the likes of which has not been seen since maybe the middle of the twentieth century. Importantly, as we keep reminding our subscribers the setup for Epicenter stocks who have been patiently sharpening their knives while waiting for pre-pandemic levels of demand to return has the best risk/reward tradeoff in our estimation.
Investing in Epicenter names is more than a trade, what you’re buying is lean, mean companies that have undergone a mandatory restructuring courtesy of the worst disaster of our lifetimes. The interruption of demand we saw makes the severely adverse scenarios in the Federal Reserve’s stress test for supervised banks seem like a walk in the park. Yet these companies have survived to fight another day and that day is FAST approaching. Again, little trickles of info keep painting the picture. Yesterday, Delta finally lifted it’s middle seat ban. Vaccine penetration continues rising. States are easing restrictions paving the way for a return to economic normalcy. Vaccines will be available to all who want one soon according to current plans.
In past economic contractions US corporates have proven themselves adept at slashing costs which has enabled many companies to exceed prior peak EBIT with far fewer revenue dollars. For instance, we showed in our past research that the Consumer Discretionary sector managed to achieve 20% higher EBIT by 2010 than the prior peak with 10% fewer revenue dollars. Given that the depression in 2020 was significantly worse than any economic devastation we’ve seen in our lifetimes, we expect that the ability of companies to adapt and cut costs will only have increased to meet the gravity of the situation they together faced. We think given the severity of the low, it is quite possible that, correspondingly, the highs to come as re-opening begins to hit its stride will exceed previous records and surprise many investors who think of these stocks as obsolete.
We conducted a theoretical forecast below for four of the five Epicenter sectors. We chose to exclude Financials since they do not have a typical revenue line (it is ‘net of credit cost’) and therefore comparing EBIT is apples and oranges. Nonetheless, we think it is a credible path for the EBIT of the four sectors included.
If Epicenter 2022E EBIT could potentially average about 120% above 2019 levels than shouldn’t the stock prices make a corresponding move? We think so. The operating leverage that stems from such an EBIT margin recovery is quite staggering. We think the Street is dramatically underestimating 2022 revenues for Epicenter names. The consensus estimates see 2022 revenues about 8% above 2019 revenues. However, if we apply the above 14% EBIT model above then EBIT would be about $111 billion by 2022, or roughly 120% above the 2019 levels.
This is exactly our point. Epicenter operating leverage is likely to come in far higher than what current consensus estimates are on the Street. We also think there’s potential for topline upside as well. Adding this together, we think investors who think that 2019 highs are some sort of a ceiling for stock prices are completely incorrect. We do not think valuations of Epicenter names are stretched at all based on our work.
Institutions have also raised cash levels by almost $130 billion since December 2020 and cash balances have not been higher since June 2020. Despite widely cited BofA surveys pointing out ebullient bullishness, our direct experience with institutional clients has shown a lot of bearishness. Everyone is being kept up at night about something and generally folks are very worried. Tick data shows that stocks have been falling in the final hour which is typically a measure of institutional activity. So, despite the numerous ‘signs’ of an impending top, we continue to follow what the market and the data are saying. A great economic boom is coming.
