A September pause?

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   By Guest Blogger Ryan Lewenza

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It’s been a pretty awesome ride in the equity markets this year with the S&P 500 and TSX both up around 19%. I think it’s safe to say this year’s returns have surprised a lot of investors (not us!) and now we’re hearing a growing chorus of ‘experts’ calling for a big drop in the markets soon. Many point to a peak in central bank stimulus as a potential catalyst for the drop.

We’ve been saying to clients for a little while now that the markets are overdue for a consolidation/pullback so we would not be surprised to see an uptick in volatility over the next few months. But, as I’ll outline, any weakness could prove to be a great buying opportunity given the very constructive macro and fundamental backdrop.

On the central bank front, the Bank of Canada was first out of the gate by cutting their monthly asset purchases back in the spring. Then the ECB followed suit by announcing this week that they are reducing their quarterly asset purchases, in part due to a 10 year high in inflation. The focus is now turning to the Federal Reserve, who has started to signal that a ‘tapering’ of their monthly bond buying program is coming. Currently the Fed is purchasing US$120 billion of bonds every month and this is likely to be cut back in the coming months. Given that central bank stimulus has been providing a strong tonic for the economy and equity markets, some are pointing to these actions as a harbinger for a big drop in the markets.

Monetary Stimulus from Leading Central Banks

Source: Bloomberg, Turner Investments

Another short-term headwind for the equity markets is seasonality. Historically, September and October have been volatile months for the equity markets. Below is a chart that shows the average monthly price returns for the S&P 500 going back to 1928. September has historically been the weakest month for the equity markets with the S&P 500 down on average 1%.

S&P 500 Average Monthly Price Returns

Source: Bloomberg, Turner Investments

So there’s definitely a few near-term headwinds for the equity markets that could lead to an uptick in volatility, but don’t lose the forest for the trees. There remain a number of positives for the economy and stock market and why we remain steadfast bulls.

First, the vaccines are effective and more and more people are getting vaccinated every day. Currently 41% of the world population has received at least one vaccine dose and roughly 30 million doses are being administered daily. This vaccine rollout will, over time, help to slowly get control of the pandemic and allow us to get back to ‘normal’ or something close to normal.

As this unfolds, we see the US/global economy strengthening with more job gains and increased consumer spending. This is why the IMF is projecting the global economy to grow 6% this year and 4.9% in 2022, which if realized, would be the strongest economic growth seen in decades.

Second, as the economy rebounds so are corporate earnings. I’ve been writing a lot about corporate profits recently and below is a chart of S&P 500 earnings. Over the last 12 months the S&P 500 has delivered earnings of $178/share, which is up from $146/share last year when the pandemic first hit. For this full-year earnings are projected to rise to $203/share and $221 for next year. Higher corporate profits is a key factor behind our bullish view.

S&P 500 Trailing Earnings

Source: Bloomberg, Turner Investments

Finally, I believe we’ve just started a new expansion cycle, which based on history, suggests a number of years of economic growth. Since 1950, expansions periods – characterized by rising job growth/consumer spending and positive GDP growth – last on average 23 quarters or roughly 6 years.

I believe the US/global recession ended last year and that a new expansion cycle has commenced. So, if history repeats, we should see the US/global economy growing for another 5-6 years before getting worried about the next recession.

Duration of US Expansion Periods Since 1950

Source: Bloomberg, Turner Investments

To sum up, equity markets have been rocking since last March so we’re probably due for a bit of a breather. But we remain steadfast bulls and see more gains ahead. So block out the noise from the ‘experts’ on CNBC or your cousin Vinny talking about the high CAPE ratio and stick to the plan.

Ryan Lewenza, CFA, CMT is a Partner and Portfolio Manager with Turner Investments, and a Senior Vice President, Private Client Group, of Raymond James Ltd.