Monday Morning Outlook
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 12/1/2020
In December 2019, we made a year-end 2020 forecast of 3,650 for the S&P 500. With the index closing Friday at 3,638, that looks like a very good call.
But we’d be fibbing if we didn’t admit to getting whipsawed by COVID-19. In the spring the S&P 500 fell as low as 2,237, pricing in a massive drop in corporate profits. We remained bullish but revised our year-end forecast down to 3,100. Then, in August, after analyzing data on COVID-19 and assessing the actual impact of shutdowns on growth and profits, we lifted our year-end S&P target for 2020 back to 3,650.
For next year, the fundamentals continue to suggest a bullish outlook. Our year-end 2021 call for the S&P 500 is 4,200 (up about 15% from last Friday), and we expect the Dow Jones Industrial Average to rise to 35,000.
We rely on our Capitalized Profits Model. The model takes the government’s measure of profits from the GDP reports, discounted by the 10-year US Treasury note yield, to calculate fair value. And, last week, corporate profits for the third quarter were reported at a record high, up 3.3% from a year ago.
The question is: what discount rate should we use? If we use the current 10-year Treasury yield of 0.84%, our model suggests the S&P 500 is grossly undervalued. But this is because the Federal Reserve is holding the entire interest rate structure at artificially low levels. Using these rates distorts valuations.
Using third quarter profits, it would take a 10-year yield of 2.8% for our model to show that the stock market is currently trading at fair value. And that assumes no further growth in profits.
Right now, in spite of Fed pressure to hold rates down, we expect the 10-year note to finish 2021 in the range of 1.25% to 1.5%. Nonetheless, we have chosen to use a more conservative 2% discount rate in our Capitalized Profits model. Using third quarter 2020 profits, that creates a fair value estimate for the S&P 500 of 5,150. And this does not take into account the highly likely boost to profits in the year ahead. As a result, we believe our year-end 2021 forecast of 4,200 is easily within reach.
Obviously, the year ahead is not without risk. Perhaps the various vaccines will be rolled-out more slowly than anticipated. Perhaps, the Georgia Senate elections in early January result in a House, Senate, and White House that all agree to more aggressive tax hikes than markets currently anticipate. Perhaps, perhaps, perhaps.
More likely, we anticipate the vaccines will work roughly as advertised, and businesses will continue to improve in handling the obstacles posed by the illness and government shutdowns alike. Meanwhile, the Senate should remain a check on aggressive tax hikes, and the federal courts may curb excesses in regulation. New entitlements? Highly unlikely. In addition, it looks like trade conflicts with other countries will ease.
We have been bullish since 2009, not because we are perma-bulls, as our detractors like to say, but because the fundamentals say we should be. Profits and interest rates drive stocks, we let these factors determine our outlook. Not politics, not fear, not greed…just math.
Date/Time (CST) U.S. Economic Data Consensus First Trust Actual Previous
11-30 / 8:45 am Chicago PMI – Nov 59.0 62.4 58.2 61.1
12-1 / 9:00 am ISM Index – Nov 58.0 57.9 59.3
9:00 am Construction Spending – Oct +0.8% +1.3% +0.3%
afternoon Total Car/Truck Sales – Nov 16.1 Mil 15.9 Mil 16.2 Mil
afternoon Domestic Car/Truck Sales – Nov 12.4 Mil 12.4 Mil 12.7 Mil
12-3 / 7:30 am Initial Claims – Nov 30 765K 765K 778K
9:00 am ISM Non Mfg Index – Nov 56.0 56.0 56.6
12-4 / 7:30 am Non-Farm Payrolls – Nov 500K 490K 638K
7:30 am Private Payrolls – Nov 608K 590K 906K
7:30 am Manufacturing Payrolls – Nov 46K 47K 38K
7:30 am Unemployment Rate – Nov 6.8% 6.8% 6.9%
7:30 am Average Hourly Earnings – Nov +0.1% +0.1% +0.1%
7:30 am Average Weekly Hours – Nov 34.8 34.8 34.8
7:30 am Int’l Trade Balance – Oct -$64.8 Bil -$64.8 Bil -$63.9 Bil
9:00 am Factory Orders – Oct +0.8% +0.6% +1.1%
The attached information was developed by First Trust, an independent third party. The opinions are of the listed authors at First Trust Advisors L.P, and are independent from and not necessarily those of RJFS or Raymond James. All investments are subject to risk. There is no guarantee that these statements, opinions, or forecasts provided in the attached article will prove to be correct. Individual investor's results will vary. Past performance does not guarantee future results. Forward looking data is subject to change at any time and there is no assurance that projections will be realized. Any information provided is for informational purposes only and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. The Dow Jones Industrial Average (DJIA), commonly known as “The Dow” is an index representing 30 stock of companies maintained and reviewed by the editors of the Wall Street Journal. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance.