The US just put the past elections behind (at least partially), Covid-19 is still battering the economy and S&P 500 is testing it’s all-time high levels. Will this bullishness continue? What to expect from the S&P 500 as we are entering the final month of the year?
Hopes vs Reality
Covid-19 Reality: Daily new cases continue to increase despite the tremendous efforts of health workers. The second wave of coronavirus starting to hit the world hard. First lockdowns come from European countries and the economy shows immediate effects of these lockdowns. EU’s PMI numbers fell below 50 very fast. The US is still trying to avoid lockdowns and shutting down the economy but some states began to set new restrictions. As the northern hemisphere is entering into winter things are only going to get worse.
Vaccine Hopes: Pfizer, Moderna, and AstraZeneca, all state that their vaccine’s effectiveness is over %90 percent. This is a level, way over expectation from the future vaccines. Yes, the logistics will be a problem; yes, poor countries won’t have access to these vaccines for a while; and yes, there are many questions about the long-term efficiency of these vaccines BUT now there is a way for a Covid-free future for humankind.
Over Valuations of Equites Reality: Covid-19 era cause lots of harm to the economy from supply chains to market demand. The unemployment rate has increased all over the world and some of them will become permanent job losses because companies learn how to produce more with less workforce this year. In this environment, general demand fell and most stocks valuation effected negatively because of falling earnings and in macro base economy fell into recession. While this is happening stock markets worldwide are reaching their all-time high levels. The US Market Cap to GDP, in other name “Buffet Indicator” is currently at %179.10 which is its record and nearly %25 higher from the start of this year. Above %135 is considered “significantly overvalued” and big correction expected near this level.
Stimulus Hopes: Central Banks from all over the world are buying assets and cutting rates as they are racing with each other, hoping to ease some of the hardships of coronavirus on the economy. Inflation and inflation expectations are below historical levels and this is giving central banks an opportunity for more asset purchases. In addition, monetary policy tools of central banks, governments using fiscal tools this year. US congress helps companies and people by providing trillions of dollars since April and currently, the EU and the US are considering more stimulus packages. Hopes of these packages and extra support from ECB and FED are fueling the bullishness of stock markets.
Crucial Note: There is a brewing crisis in the US right now about unpaid rents. With the help of the CARES Act, a lot of people paid part of their rent but as the high unemployment continued throughout the year unpaid rents began to accumulate. According to Philadelphia FED, households could owe 7.2 billion rent at the end of the year. Currently, because of the national moratorium, households cannot be evicted until 2021. Unless a new stimulus package agreed upon by Congress, the economy may take a big hit in the first quarter. In addition to the unpaid rent problem, hundred of thousands of people will lose their unemployment benefits in early 2021.
Over Valuation
Currently, the S&P 500 is pricing near 28.5x P/E ratio. This means a lot more than its 5 year +3 standard deviations of 22.8x which can be considered as extremely overvalued. Is S&P 500 really that overpriced?
The answer to that question is: “Yes, but not entirely.”. Current P/E is near the level of the 2000 dot-com bubble crisis. But the difference between these two eras is FED. FED cut the rates near zero and fueling the markets with cheap money while purchasing assets aggressively since 2008. This year alone FED increased their assets by more than %70. Low yields and continuous stimulus when every time the stock market is down is supporting the high P/E ratio over medium to long term. Is this not a bubble? Probably yes, it is but this bubble can have the capacity to get even bigger with all the help from central banks and may take years before it burst.
Analysts expect a decrease for the 4th quarter of this year and slow recovery at the first quarter after 2021 for equities. After the first quarter, however, a strong rebound like the famous “V” shape is expected that may surpass 2018-2019 earning levels.
The current basic EPS and Expected EPS spread is near 40 levels. At the last time, this spread near this level an uptrend start for S&P 500 which continue for over one year until Covid-19 shock.
12 Month Target Price
12 Month target price for the S&P 500 is 3900 according to Bloomberg weighted BEst which is supporting the high P/E expectations for 2021.
Technical Analysis
Upward trend continues to gear up over long term which is over %250 level of the original trend. A bullish triangle like pattern is may be forming over 3.560.
Spearman indicator usually stays near plus or minus 80 levels, spends little time in the middle of them. This year, it reversed from near-zero levels two times after a sell signal occur. After this two times, at least a half month uptrend formed. This may happen again in the near future. Price starts to reverse again which may be a bullish signal for S&P500.
Price reverse to the upside like a double bottom between 3200-3300 levels and price is contracting near all-time high levels. If 3660 breaks above we may see another bullish run. But 3560 is going to be an important support level, below that level bears may come into play.
December Seasonality – Is Santa Coming to Markets This Year?
December is known for Santa Claus Rally. The final week of December and the first days of the new year is usually bullish because of lots of reasons like tax rules, investing at the end of the year bonus payments, and general optimism. Last ten years price perform around %0.48 in December and if we exclude -%9.18 from 2018 it is around %1.55.
Final Notes
- S&P 500 is overpriced but the current economic situation is allowing overpriced stocks for at least medium-term. This may slow the longevity of bullish runs. S&P 500’s direction may continue to be upward as long as central banks and governments support the economy.
- 2020 is a disastrous year for the world. Nearing the new year may increase optimism as vaccine news continue to pile up.
- Expectations for equities to recover lost earnings in the second half of the year. First-quarter may become volatile because of vaccine hopes and rising cases of Covid-19 fears.
- If the price breaks above 3660, December can be a good month for markets. A new stimulus package from Congress with FED and ECB increasing their assets may support that probability.
- Downside corrections in short term may be fast and hard but short-lived. Short term or day traders should be careful about their positions.
- The trend around 3560 may be a good support and give hint for direction about price
- The looming problems about unpaid rents may cause big problems in January if not addressed by Congress.
