How Luke Lango is sizing up 2021 … why historically-high valuations aren’t as scary as they seem … the type of stock that will lead next year’s gains
Will stocks continue their upward climb in 2021, or will they finally crash into the ceiling of high valuations and disappointing earnings?
On Monday, we got Matt McCall’s thoughts.
In short, he believes 2021 will be a profitable year for stocks, but with greater volatility. He’s calling for two 10% corrections.
Today, let’s check in with another of our expert InvestorPlace analysts — Luke Lango, editor of The Daily 10X Stock Report.
In Luke’s weekly update from last Saturday, he tackled the issue of today’s lofty stock market valuations.
Frankly, this is the critical issue investors must grapple with when looking at 2021 — and not everyone is making a bullish case.
For example, as we noted in Monday’s Digest, the team over at the investment shop, ValueWalk recently wrote about the potential for a 42% crash next year based on today’s valuations.
If we look at valuation, the probabilistic outlook is very, very bad from a long-term perspective. The market is at the most expensive levels, it has ever been.
So, for those who believe the market is headed higher in 2021, how is it going to do that when starting from today’s historically-high valuation?
This is the challenge that Luke will address for us today.
Let’s jump in.
***The most expensive market since the Dot Com bubble
For newer Digest readers, The Daily 10X Stock Report was created earlier this year for one sole purpose:
Deliver to your inbox — every day the market is open — a top-notch small-cap stock pick that could rise by 1,000% or more in the long run.
Luke’s subscribers recently toasted their first-such 10X winner — Chinese electric vehicle company, NIO. And it didn’t exactly require “the long run” for it to happen.
As I write, 10X subscribers who acted on Luke’s recommendation back on May 27th have watched NIO climb more than 1,300% before its recent breather (it’s still up more than 1,000%).
Now, given Luke’s challenging task of finding 10X picks, he’s especially sensitive to the condition of the broader market. After all, it’s far easier to find a 10-bagger in a healthy, surging market than it is in a languishing, weak market.
This means Luke has had to grapple with the number-one headwind facing the market today — expensive stock market valuations.
Here’s how Luke is sizing this up:
With stocks continuing to climb ever higher, the stock market as a whole has entered dangerous and largely unprecedented valuation territory.
The S&P 500 now trades at 22.1-times forward earnings. That’s the largest forward multiple the market has traded at since the Dot Com Bubble.
It’s also 27% above the market’s 5-year average forward multiple (17.4) and 42% above the 10-year average forward multiple (15.6).
Ostensibly, those are some scary numbers.
Below, you can see how this looks.
The chart you’ll see in a moment shows the forward price-to-earnings multiple for the S&P 500 since 1999. As Luke just pointed out, we haven’t seen these valuations since the Dot Com era.
This is illustrated in the top-pane below, which represents the S&P 500 — so, large-cap stocks.
But also note the bottom two panes. They show the S&P 400, which represent mid-cap stocks, and the S&P 600, which are small caps.
Today, they’re also trading at Dot-Com-era levels.
Source: Yardeni Research
Markets tend to mean-revert over time. And typically, the further “stretched” a market valuation becomes, the more likely it is to revert.
It’s similar to a rubber band — the more you pull it to its elastic limits, the greater the pressure grows for it to return to “normal.”
The charts above show a highly-stretched market. Given this, how is Luke still bullish?
***Putting context around today’s expensive valuation
Back to Luke:
Interest rates are stuck at zero, with the Fed committing to a zero-interest-rate policy for the next three years (at least).
In a zero-interest-rate environment, fixed income instruments tend to yield close to nothing — so everyone rushes into stocks to get any sort of return that beats inflation.
This dynamic naturally inflates the market’s valuation.
Importantly, this dynamic will remain in-place so long as interest rates remain stuck at zero, and therefore, stocks deserve to trade at inflated multiples for the foreseeable future.
Luke’s point is critical to factor in.
A zero-interest rate world fundamentally changes what we should consider an “average” valuation. Especially when combined with the tsunami of debt and newly-minted fiat currency now flooding the global economy.
Billionaire hedge fund manager, Ray Dalio agrees. Earlier this week, Dalio said he sees no reason that stocks couldn’t trade at 50 times earnings.
So, yes, forward price-to-earnings multiples are expensive by historical standards, but less so when we factor in the economic realities of today.
***Don’t forget about earnings
So far, we’ve focused on the “price” part of the forward price-to-earnings ratio.
But what about the earnings part?
Is it possible that here too we need to take the number with a grain of salt?
Back to Luke:
Even further, today’s forward earnings base isn’t a great measure on which to value stocks.
In this case, forward earnings comprise earnings from the fourth quarter of 2020 to the third quarter of 2021.
Most — if not all — of those quarters will be harshly impacted by COVID-19.
But with highly effective vaccines in the pipeline, we know that COVID-19 is a temporary headwind which will very likely phase out by late 2021. Thus, the economy won’t be “normal” again until 2022, and therefore, earnings won’t be “normal” again until 2022.
Indeed, if you look at Wall Street consensus earnings estimates, the S&P 500’s earnings per share are expected to jump more than 16% from $168.67 in 2021, to $196.35 in 2022 — and those 2022 estimates are climbing higher every week.
In other words, the market today isn’t so much greedy, as it is just forward-looking.
***A numbers-based estimate of coming market returns
At this point in his update, Luke walks his subscribers through some simple earnings-based calculations to ballpark future returns.
In short, using 2022 earnings estimates combined with a fair valuation multiple given our zero-interest-rate environment, Luke projects a 2021 price target for the S&P 500 of 4,200.
Here he is for the takeaway:
The S&P 500 today trades around 3,700.
In our very realistic and plausible scenario, then, the stock market has about 14% upside potential over the next 12 months …
The implication, of course, is that you should stick with stocks.
Taking that one step further, you should especially stick with hypergrowth stocks, because in a rising market tide, hypergrowth stocks tend to lead the pack.
As illustration of this last point, I’d point back to Luke’s 1,000+ gainer in NIO.
More recently, there’s been Luke’s LiDAR pick, Luminar Technologies. As I write Thursday morning, it’s up 174% since Luke profiled it on September 17.
Or there’s MicroStrategy, which was Luke’s pick on October 8 — it’s already up 87% (it was as high as 131% up before pulling back recently).
These gains echo Luke’s point — hypergrowth stocks lead the pack.
Wrapping up, yes, we have an expensive market today. But when we dig into the details, there are logical reasons why stocks can continue climbing from here.
And if Luke’s right, we’ll be enjoying double-digit gains in the broad market next year, supporting a slew of triple-digit hypergrowth winners. We’ll keep you up to speed on all of this here in the Digest.
Have a good evening,