Page 15 - ISQ January 2021

JANUARY 2021

“
... we maintain a positive view on the equity
markets. This stance stems from our expectation
for an economic recovery ... ”

Additionally, questions remain about the ongoing virus surge, vac- further move upward. This $175 estimate is a 27% snap-back in
cine capacity and distribution, timing and size of stimulus, and the growth from 2020’s pandemic-depressed earnings (and 9% above
pace of the economic recovery. So while we are positive on equities 2019 earnings).
over the next 12 months, we would not be surprised for the road We also believe valuation multiples can remain elevated given the
to be bumpy along the way.
low inflationary and interest rate environment. The current S&P 500
P/E of 27.5x is well above the historical average of 16.5x. However,
S&P 500 TARGETS when taken in conjunction with still low interest rates, the current
(BASE/BULL/BEAR CASE SCENARIOS) valuation is more reasonable in our view. For example, the equity
Our base case S&P 500 target for 2021 is 4,025 ($175 EPS, 23x P/E). risk premium (S&P 500 earnings yield vs. US 10-year Treasury yield)
We use $175 in earnings, above the current consensus estimate of is currently 2.6%. This remains well above the long-term average
$166, due to our positive expectation on the economic and funda- of 0.6% (since 1954) and just marginally below its pre-pandemic
mental recovery in the year ahead. It is also normal for estimates level last January. Moreover, the S&P 500 dividend yield of 1.5% is
to be revised higher coming out of recessions, as analysts histori- 0.5% higher than the US 10-year Treasury yield. Despite equities
cally set the bar too low in dire economic times. This is the exact being at all-time highs, this is still in line with the highest spreads
opposite of normal times when analysts typically set estimates too on record prior to COVID-19- reflecting a still attractive environ-
high and have to revise lower into the actual results. For example, ment for equities versus bonds in our opinion. It is also normal for
coming out of the last two recessions, S&P 500 earnings estimates valuations to elevate coming out of recessions due to depressed
for the following year (2004 and 2010) trended higher from the bear earnings as investors discount the eventual recovery. As earnings
market low to year end by 3-5% and continued in the following rebound in 2021, we expect the S&P 500 P/E multiple to contract.
year by another 8-10%. In the current timeframe, 2021 estimates However, the Fed has stated its intent to keep interest rates lower
have been revised higher by 4% so far (in line with those previous for longer in order to support the economic recovery, which also
periods), and our earnings estimate of $175 reflects just a 4.5% supports above-average multiples in our view. Therefore, we use
a 23x P/E in our base case 2021 scenario which, combined with
2021 Year-End Outlook our $175 earnings estimate, produces a S&P 500 target of 4,025.

In a bull case scenario, we believe the S&P 500 can trade to 4,180.
EPS ESTI-
S&P 500 MATE P/E PRICE In the event that the virus spread subsides and COVID-19 vaccina-
tions allow a quicker reopening process (in conjunction with fiscal
Bull Case $190 22x 4,180 stimulus) that results in upside to growth expectations throughout
2021 (i.e., GDP growth is closer to ~6.5% than ~4.5%), we believe
S&P 500 earnings could potentially reach $190. With this stronger
Base Case $175 23x 4,025 growth backdrop, it is likely that inflation and interest rates are
marginally higher than under our base case scenario, resulting
in a slightly lower valuation assumption. We use a 22x P/E in this
scenario as valuation also normalises at a quicker rate. Applying
Bear Case $160 20x 3,200 this 22x P/E to $190 earnings results in a bull case S&P 500 target
of 4,180.

Source: Raymond James Equity Portfolio & Technical Strategy

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