Searching for New U.S. Stock Market Catalysts

The S&P 500, the benchmark index of the broader U.S. market, has reached new all-time highs in the past few weeks, driven by an impressive series of positive economic surprises. The size, scale and scope of stimulus from the Federal Reserve and Congress has delivered a much faster than expected recovery in manufacturing, housing and labor markets. Now the initial rollout of vaccines has investors looking past the frightening numbers of COVID-19 deaths, hospitalizations and cases. 

A boom in successful initial public offerings suggests that animal spirits are back. The amount of money raised this year by new public companies has crushed the dot-com historic high in 1999 by more than 35%—in fact, double, if we add special-purpose-acquisition-company deals, or SPACs.

We remain bullish overall and still expect a powerful V-shaped economic recovery next year. However, investors shouldn’t ignore growing signs that positive market catalysts may have run their course and caution is warranted. Consider these points:

• Improving fundamentals may already be priced into stocks. Corporate earnings growth could average 25% in 2021, according to a consensus estimate compiled by FactSet—an ambitious forecast that would require a complete reopening of leisure, hospitality and entertainment sectors. Positive earnings revisions are now running at their swiftest pace in more than 20 years. Forward price/earnings multiples are at extreme levels relative to the past 20 years (22 vs. 15 historically for the S&P 500). This is despite the fact that inflation expectations and long-term interest rates are rising. Those conditions typically lead to lower stock multiples, which we expect.

• Investor sentiment and portfolio positioning indicate investor complacency. According to brokerage firms, cash held in client accounts is estimated to have fallen to 12% at the end of November, from 21% in August. We’ve seen assets held in money-market funds decline for both retail and institutional accounts. Most tellingly, individual investor bullish sentiment, as measured by the AAII Investor Sentiment Survey, has risen to extremes, with bulls outpacing bears now by 26 percentage points, compared with the 7.5-percentage-point 60-year average for this spread. Another indicator: Short interest for the median stock in the S&P 500 has fallen to its lowest level in nearly two decades. These signs of bullishness have historically been contrarian indicators.

• Fiscal and monetary policy stimulus may be near maximum levels. The Fed has committed to keeping its key short-term interest rate near zero through December 2023 and has already deployed every means possible to stimulate the economy, leaving it with only modest short-term tools. Many investors expect another round of federal government stimulus, to the tune of $900 billion, which seems the largest package that a divided Congress would likely pass.

The question investors should consider now: What else could go right that isn’t already discounted? It will likely take new catalysts for stocks to rise further from here. A Democratic sweep in Georgia Senate races that could lead to an expansionary Biden agenda around infrastructure could be one outcome that isn’t yet priced into markets. But given current polling, the probability of that happening is only 20%.

We remain confident in our reflationary call for a strong 2021 global economy. However, the S&P 500 has just 6% to go before it hits Morgan Stanley & Co.’s 2021 year-end price target of 3900. Given the high expectations already priced in the S&P 500, we believe it will be increasingly important for investors to focus on patient, disciplined and opportunistic security selection, in addition to the portfolio strategies we are recommending for 2021 and beyond.

This article is based on Lisa Shalett’s Global Investment Committee Weekly report from Dec 14, 2020, “Searching for Unpriced Catalysts.” Ask your Financial Advisor for a copy or find an advisor. Listen to the audiocast based on this report.