(Bloomberg) – To get the stock market right in 2020, it had to be forgotten almost everything that made 2020 a year to remember.
A deadly virus that is spreading unabated in the United States. A historically brutal recession and a slump in profits. Widespread unrest. Political uncertainty that has not yet been fully resolved. Add to this stock valuations that haven’t been that rich since the days of the dot-com bubble.
None of this mattered, at least not for long, to a market that seemed to see through the fog of uncertainty and focused on a rebound in 2021. The final chapter of this strange year has yet to be written, and the markets have a reputation for sometimes doing the opposite of what the consensus expects. But at least in the past week, promising test results for a coronavirus vaccine have rewarded investors who have retained confidence. The S&P 500 closed at a record high on Friday after a second consecutive weekly win.
“Every company recently bought here was bought with the expectation that at some point we would get the virus under control, business will take off, and then those ratings will be warranted,” said Randy Frederick, vice president of trading and derivatives for the Schwab Center for Financial Research. “We often buy a quarter in advance. Now we’ve bought three or four quarters in advance. “
That focus this week was on a vivid display. In the United States, virus cases soared, records of hospital stays and new cases were being kept daily, and several states and cities were re-imposing some restrictions. With Pfizer Inc. and BioNTech SE announcing promising results for their vaccine, virus developments weren’t enough to stop cops from pouring a record amount into stock funds.
While questions about production, distribution, and the ability of the shot itself remain open, investors have been quick to dump home-style trades like technology and embrace small caps and banks, stocks that can benefit from an economic recovery. The tech-heavy Nasdaq 100 fell more than 1% during the week, while the Russell 2000 small cap index rose more than 6% to an all-time high. The KBW Bank Index had its best week since June with a plus of 11%.
The vaccine announcement has caused much of Wall Street to rethink its earnings estimates for 2021, a development that should alleviate some concerns about the valuations. At the close of trading on Friday, the S&P 500 was trading at 22x the 2021 consensus earnings estimate of $ 165 per share, representing earnings growth of around 22%.
Due in part to the vaccine news, strategists at JPMorgan Chase & Co., led by Dubravko Lakos-Bujas, raised their 2021 earnings forecast for the S&P 500 by $ 8 to $ 178 per share. Based on that forecast, the multiple of the S&P 500 would drop to 20.
“Valuation is ultimately the biggest hurdle for next year,” said Mark Freeman, chief investment officer at Socorro Asset Management LP, over the phone. “So the vaccine news is an important step in confirming market expectations in this regard.”
In a year when no one could predict with great confidence what would happen to Americans in the wake of the pandemic, investors tended to write that off entirely. Thanks to monetary and fiscal support, stocks have resisted declining earnings this year, adding more than $ 15 trillion in value since the bear market bottomed in March.
The vaccine development means Corporate America’s profitability may be grossly underestimated, according to Jim Paulsen, chief investment strategist at Leuthold Group. Although companies beat expectations for the third quarter at a record pace, analysts’ forecasts for 2021 for earnings for the S&P 500 have only increased 1% since late September. Paulsen sees earnings potential at up to $ 200 per share. This implies a price-earnings-ratio of 17.9, which is close to the average multiple of the index over the past five years.
“Economic growth has returned much faster than expected and has remained much firmer,” said Paulsen. “When you factor in the momentum plus the impact of stimulus plus vaccine discovery, I think the growth estimates for 2021 are grossly underestimated, and that also tells me the earnings estimates are.”
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