Investor Focal Points To Start 2021

The reality is that P/E ratios do, indeed, expand over time; we just haven’t seen such levels of expansion so rapidly. To wit; we’ve never had such significant, rapid fiscal and monetary policy collide with a self-induced recession either.

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It’s extremely difficult to ask investors/strategists/analysts to use the average P/E ratio over the past decade to reflect the probabilities for valuations going forward given such unprecedented circumstances. Moreover, the free cash flow levels, low-interest rates, and monetary policy continue to push investors toward risk assets, providing the potential for P/E expansion sustainability. (graphic from Chris Ciovacco)

Research Report Insight #8

I will continue to track how well the 2021 path of the SPX (orange line) follows the path of the SPX in 2010 (green line). It is worth watching given how closely correlated 2009 & 2020 were. No one knows if it will continue into 2021, but if it does, it may imply a potential pullback of about -5% in the latter part of January and before lifting higher once again.

Roadmap

The potential drawdown mentioned does not align with much of the data we have covered in recent weeks, but this is also why we remain flexible and open to a wide variety of outcomes.

The current bull market, which began on 3/23, is now 283 days old and as of the last high record high (12/31), the S&P 500 was +67.5 percent. It is still the shortest bull market by far, but its strength has already surpassed 2 others. (Data/chart Charles Schwab)

Bull Markets

Research Report Insight #9

J.P. Morgan’s Marko Kolanovic discusses his outlook for 2021, which also highlights volatility’s impact on the S&P 500 as follows:

The figure below shows that average VIX levels closely follow levels of interest rates with an ~18-month lag. Given the significant increase of monetary accommodation 9 months ago, we expect it to pressure volatility for most of 2021. Volatility also correlates with various macroeconomic variables related to economic growth, employment, housing, consumer confidence, etc. We analyzed ~100 of these relationships and found that most of them (95 out of 100) indicate the VIX should be lower, averaging 17.7 (Figure 2).

“A decline in volatility creates a positive feedback loop, where systematic and discretionary hedge fund strategies increase allocation to equities. This process may take most of 2021 to play out, as the economic recovery as well as inflows in the risky strategies are likely to be gradual. For instance, if strategies’ exposure goes from current below average levels (CTAs ~40th %tile, VT & RP ~15th %tile, Hedge Funds ~25th %tile ) to ~65th historical percentile, this would result in ~$250bn inflows for systematic funds and ~$300bn inflows for Hedge Funds. 

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