As we wrap up 2020 it is worth highlighting what a roller coaster year it was for the market.
Midway through December the S&P 500 had advanced more than 13%, a result that appeared highly unlikely during late March when shares fell sharply on COVID-19 fears. However, the market is forward-looking and global support in the form of fiscal and monetary stimulus has helped drive markets higher since the spring. Currently, the prospect of further stimulus combined with the fastest development of a vaccine ever recorded has boosted investor optimism and provided hope that a return to a more normal environment is on the horizon.
Given the supply of inexpensive capital, growth is at a premium. Companies demonstrating good growth with large addressable markets are experiencing optically high valuations. This is justified if these companies can fulfill their promise by capturing a significant portion of their potential markets. However, it appears the market is assigning high multiples to a wide swath of companies meeting this categorization. This looks to us like it underestimates the difficulty of achieving market dominance. Undoubtedly, some will be successful while many others will serve as tomorrow’s cautionary tales.
Aided by historically low interest rates, overall market multiples remain high. According to FactSet Earnings Insight, the forward P/E ratio for the S&P 500 is nearly 22x, above the 5-year average of 17.4x. Clearly, earnings continue to be suppressed by pandemic-related headwinds, though those should wane as we progress through 2021.
Earnings are expected to decline nearly 14% in 2020, marking the largest annual earnings decline since 2008. In 2021, projections are for nearly 22% earnings growth. The 2021 projection represents a welcome return to something better approximating normalcy and an approximate 5% increase over non-COVID-impacted 2019 results. It’s hard to argue with the market’s year-to-date returns in 2020 but we doubt many are reluctant to turn the calendar to 2021. Cue up Auld Lang Syne.
From the January 2021 issue of the Investor Advisory Service.