S&P500 has clocked its sixth consecutive month of gains in July 2021. This is the longest stretch since 2018. Furthermore, S&P500 has touched a record high to close at 4,437 on 6 Aug 2021.
In the next 3 months, are markets poised for higher highs? Or should we be prudent and take some profit off the table first?
Let’s take a look.
Ernest’s personal market observations
a) Lack of catalysts to push the market higher
Since Covid last year, markets, especially U.S. markets, have been able to push higher due partly to the combination of ultra-easy monetary policies; expansionary fiscal policies; improvement in the Covid 19 situation leading to the re-opening of economies; improving company results; low valuations (especially around Mar 2020 time) etc. However, after a blistering 102% gain from 23 Mar 2020 to 6 Aug 2021, it is likely that most of these factors may arguably have been priced in.
What is important is that some of these factors may not be around in future. Read on for the elaboration below.
b) Possibility of higher taxes in a reconciliation bill
Based on articles that I read, U.S. Senate is planning to advance two major pieces of infrastructure legislation, namely the infrastructure bill and the reconciliation bill. In the reconciliation bill, it may lead to a higher corporate or individual tax rate.
c) U.S. Covid 19 cases reach 6-month high
Although most market watchers do not foresee U.S. to engage in a country wide lockdown due to the rising Covid cases, it is noteworthy that U.S. covid cases have recently reached a 6-month high. Furthermore, based on Reuters’ data through 4 Aug, U.S’ seven-day average of new reported cases have jumped almost five-fold to reach approximately 95,000. If the situation worsens, it may have an adverse impact to the U.S. consumers and the economy.
d) Drawn out debt ceiling fight may increase share price volatility
Although the base case is that U.S. should eventually resolve this debt ceiling and to avert a government shutdown, it is almost certain that there may be some back-and-forth discussions on this, leading up to the Oct / Nov timeline. Such back and forth discussions may cause some volatility in the markets, especially when the U.S. markets are trading on stretched valuations and a lack of positive catalysts.
e) Ultra-easy monetary policies may start to ease in the next few months
In June, Fed Chair Powell’s surprising hawkish tone spurred a mini sell-off in the equities markets. On 4 Aug 21, Fed Vice Chair Richard Clarida was also rather hawkish. He said there is a possibility that U.S. may hike interest rate in early 2023. Together with him, three other Fed members also said they are inclined to move to taper bond buying later this year or early next depending on the labour market over the next few months.
I believe we should get some clarity during the annual event at Jackson hole (27-29 Aug) or / and the Fed meeting on 22 / 23 Sep.
f) Challenging U.S China relations
U.S. China relations have not been exactly amicable even after Biden’s Presidency. Moreover, U.S’ recent US$750m arms sales package to Taiwan does little to help the already strained U.S. China relationship. Based on an article on Bloomberg dated 8 Aug, China just reiterated to U.S. to respect Chinese sovereignty and stop interfering in Hong Kong affairs. I.e., there are various flashpoints between U.S. and China besides trade tariffs. Any developments on the flash points may have a positive / negative effect on the markets, depending on how the developments progress.
g) Stratospheric valuations
Based on Chart 1 below, S&P500 is trading at 4.6x P/BV and 3.1x P/S, approximately 2.7x and 3.0x standard deviations away from its 10-year average respectively. For P/E, S&P500 trades at 27.1x current PE which is almost two standard deviations away from its 10-year average of 19.4x. In other words, S&P500’s valuations are high on a relative basis.
Chart 1: Valuations >=2 standard deviations away from 10Y average
Source: Bloomberg 8 Aug 2021
h) Underlying signs of unease are growing in the markets
As the rally in the U.S. markets marches on, there seems to be underlying signs of caution. Based on a Reuter’s article dated 23 Jul 2021, the dominance of the U.S. mega caps may be masking underlying signs of caution. Firstly, the combined market cap of Apple, Alphabet, Amazon, Facebook and Microsoft is approximately 24.6% of the entire S&P500’s market cap, nearly the highest proportion it has been in 2021. Secondly, unlike in April 2021 where more than 90% of S&P500 companies traded above their 50-day moving averages, less than 50% of the S&P 500 stocks recently traded above their 50-day moving averages. Thirdly, based on chart, S&P500 is exhibiting bearish divergences among a myriad of indicators such as RSI, OBV, MFI, MACD etc. Fourthly, short interest in the SPDR S&P 500 ETF Trust seems to be generally climbing higher.
i) U.S. corporate results were excellent but…
U.S 2QFY21 results have been sterling. Based on Refinitiv, 443 S&P500 companies have reported earnings to date (6 Aug 21) and 87% have exceeded analyst estimates. This compares favourably to a long-term average of 66% and prior four quarter average of 83%. Furthermore, 2QFY21’s earnings growth rate is likely to be higher by a staggering 93% vs the same period a year ago. However, I will like to draw your attention to two factors.
Firstly, the results period is nearing the end. For the week of 9 Aug, only approximately 14 S&P 500 companies are expected to report quarterly earnings. Secondly, based on Refinitiv, the earning growth rate for 3QFY21F may be lower, at around +30% on a year-on-year (“y-o-y”) basis. Although a +30% y-o-y earning growth rate is still a good number, 2QFY21 marks a peak in earnings growth. Collectively, there may be fewer positive catalysts from the corporate results to push the S&P higher.
To sum up, markets, especially the U.S. markets (as represented by S&P500), may be volatile in the next three months. This is because there may be a lack of positive catalysts to push it higher than the current record highs [See my above points].
Notwithstanding the above, it is important to note that I am not saying that the U.S. will be on a long-term downtrend. What I am saying is that I personally think that markets may be volatile in the next three months. If there is meaningful weakness, I may accumulate. Meanwhile, at current levels, I am starting to switch out of some stocks this coming week, and perhaps do some opportunistic trading in Singapore listed companies whose results are scheduled to release this week. Nevertheless, in the next 2-3 weeks, I am likely to reduce my overall percentage invested to <=50%. [As usual, my clients will be informed of my portfolio changes.]
Like other investors, I do not have any crystal ball to foretell the future. Hence, I hasten to add that the answer on whether this is a good time to buy, or sell depends on your percentage invested; market outlook; portfolio constraints; opportunity costs; risk profile etc. Thus, for those who are unsure, it is better to seek a professional financial adviser for advice.
What are the stocks to take profit, or accumulate on weakness?
I have sorted some SGX listed stocks by total potential return using Bloomberg data as of the close of 30 Jul 2021.
I have generated two tables below and have appended the top ten and bottom ten stocks for readers. Table 1 lists the top ten stocks sorted by highest total potential return. These top ten stocks offer a total potential return of between 40 – 87%, based on the closing prices as of 30 Jul 2021. (Most importantly, please refer to the criteria and caveats below). [My clients will receive the entire list of my compilation of 98 stocks sorted by total potential return.]
Table 1: Top ten stocks sorted by total potential return
Source: Bloomberg 30 Jul 2021
Table 2 lists the bottom ten stocks sorted by total potential return. These bottom ten stocks offer a total potential return of around +4% to -29%, based on the closing prices as of 30 Jul 2021.
Table 2: Bottom ten stocks sorted by total potential return
Source: Bloomberg 30 Jul 2021
Criteria in generating the above tables
1.Mkt cap >= S$500m;
2.Presence of analyst target price.
Very important notes
1.This compilation is just a first level stock screening, sorted purely by my simple criteria above. It does not necessary mean that GHY Culture is better than Jardine C&C in terms of stock selection. Readers are still required to do their own due diligence and form their own independent investment decisions;
2.Even though I put “Ave analyst target price”, some stocks may only be covered by one analyst hence may be subject to sharp changes. Also, analysts may suddenly drop coverage. Furthermore, Bloomberg may not have captured all the analysts’ target prices and some of these target prices may not be the most updated figures;
3.Analyst target prices and estimated dividend yield are subject to change anytime, especially after results announcement, or after significant news announcements;
4.The above data is compiled using Bloomberg information as of 30 Jul 2021 (closing prices).
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