Can this monster, multi-year bull continue? … why Louis Navellier is bullish … don’t expect all stocks to outperform … how valuation headwinds will resolve

 

Can the party continue here in 2022?

Last year, the S&P climbed 27%.

It also notched a dizzying number of all-time highs – 70 of them. That’s the most since 1954, when it hit 77.

Rewinding to 2020, the S&P was up 16%. And in 2019, it soared 29%.

In fact, starting in 2009, we’ve only seen two down years in the S&P. There was 2015, when it took a breather of less than 1%, and 2018, which shaved off 6%.

The rest of the years have been in the green, with some monster winners in there.

Here’s how that looks:

When we crunch the compounded returns, beginning January 1, 2009, the S&P is up 427%.

Clearly, this has been an amazing run for stocks. But the question that opened today’s Digest – the one on everyone’s mind – is “can it continue in 2022?”

***Yesterday, legendary investor, Louis Navellier, suggested that not only can it continue, the gains could even accelerate

For newer Digest readers, Louis is a legendary quantitative investor. “Quant” simply means he uses numbers and algorithmic rules to guide his investment decisions. Forbes even named him the “King of Quants.”

In yesterday’s issue of Accelerated Profits, Louis laid out the case for more gains. Let’s pick up with him explaining why January could see a leg higher, which could extend throughout the year:

The stock market “melted up” when (2021) year-end tax selling was finally exhausted, and folks were filled with the holiday spirit. The melt up came on light trading volume, given that we were in the holiday season and much of Wall Street was off celebrating.

So, what happens when trading volume picks back up in January, thanks to new pension funding and the traditional increase in trading volume?

A real “January effect” should ensue, and many small- and mid-cap growth stocks should surge.

The ultra-low Treasury yield should also add to the stock market’s strength this month and throughout the year. The 10-year Treasury currently has a yield of only 1.57%. So, yield-hungry investors should continue to flock to the stock market.

Now, when you consider that there should be persistent international buying pressure for U.S. Treasuries in 2022, as well as the fact that we still have an accommodative Federal Reserve, a strong U.S. dollar and cooling inflation later this year, I can easily make the argument that the S&P 500 could appreciate 40% in 2022!

***Before we start toasting another monster year, let’s throw in a wrinkle that suggests we need to be selective in our stock picking today, even though 40% gains are possible

The S&P 500 is hovering around its all-time high. So, it’s blue skies for everyone, right?

Not exactly.

Hidden beneath the shiny veneer of this all-time high is an index with a great deal of underperforming stocks.

To make sure we’re all on the same page, the S&P 500 Index is comprised of a shade more than 500 of the largest companies in the United States (505, to be exact).

However, all of these companies don’t get equal representation in the index. That’s because the S&P is “weight-averaged.” In other words, the bigger the company, the more “representation” it has in the index. Given this, when we look at the S&P’s overall return, we’re not viewing an accurate depiction of how its average stock is performing.

To illustrate, if each company in the S&P 500 received an equal weight, that would mean a standard allocation of roughly 0.20%. Instead, the biggest company in the S&P 500 – Apple, with a new, record valuation of $3 trillion – gets a 6.9% weighting. That’s followed by Microsoft at 6.3%, and Amazon at 3.6%.

This means that these mega-cap tech stocks have an outsized influence on the performance of the S&P 500. If they do well, it goes a long way toward the appearance of the overall S&P doing well.

***But if we’re trying to get a sense of how all the S&P stocks are doing, this isn’t the best index to evaluate

Instead, we’d look at a different index – the S&P 500 Equal Weight Index. As the name implies, this gives us the equal representation we’re looking for.

Below, let’s compare the S&P Equal Weight chart to the S&P over the last six months.

You’ll see that while the S&P is up 11.2%, the Equal Weight index is up just 8.1%. That’s a massive 28% relative underperformance.

Here’s Morgan Stanley:

The median S&P 500 stock has corrected 15% from its 52-week high. However, the index is down only 3.5%.

What’s keeping the index aloft is that the 15 largest companies now account for 40% of the index’s market capitalization.

So, what are we to make of this?

Well, for one, forget headlines about “the market” and its all-time-highs. There’s plenty of weakness lurking about that you need to avoid.

***Many of these underperforming stocks are about to face a new challenge – tougher earnings comparables.

Back to Louis:

Remember, year-over-year earnings comparisons won’t be easy this year, and fewer companies will be able to achieve accelerating earnings growth.

So, as the stock market narrows and investors grow more fundamentally focused, I expect the crème de la crème to rise to the top.

Fourth quarter 2021 earnings season begins in a couple weeks. For a preview of what to expect, we can turn to FactSet, which is the go-to data analytics company used by the pros.

From FactSet:

As of (12/17/21), the S&P 500 is expected to report (year-over-year) earnings growth of 21.3%, compared to the estimated (year-over-year) earnings growth rate of 20.9% on September 30.

If 21.3% is the actual growth rate for the quarter, it will mark the fourth straight quarter of year-over-year earnings growth above 20%.

The unusually high growth rate is due to a combination of higher earnings for Q4 2021 and a comparison to weaker earnings in Q4 2020 due to the negative impact of COVID-19 on a number of industries.

As Louis just noted, these easy comparisons won’t repeat throughout the rest of 2022.

Couple that with the reality that many S&P holdings are already well-off their highs, and it suggests that sticking with only fundamentally strong stocks could be critical to helping boost your portfolio this year – regardless of what “the market” does.

***One last reason to make sure you’re being extra-selective today

Stock valuations are well-above historical averages.

You already know this. But let’s look at it visually.

Below, we turn back to FactSet. They present a chart showing the forward 12-month price-to-earnings (PE) ratio for the S&P 500.

You’ll also see a dotted green line, which is the 5-year average forward 12-month PE, and a dotted blue line, which is the 10-year average forward 12-month PE.

In short, today’s forward PE ratio is very high relative to historical averages. Here’s how that looks:

Now, even though markets can remain in a state of imbalance for far longer than many investors believe (and can handle financially), eventually, they revert to the mean.

For the forward 12-month PE to revert to its longer-term average, one of two things must happen (or both):

• Stock prices must fall
• Earnings expectations must rise

If we look at the entire S&P 500, which of these two outcomes do you believe is more likely? Especially in light of the tougher earnings comparables in 2022, the potential for more economic reopening challenges due to Covid, and rising interest rates?

Here’s some selected commentary from the big bank analysts showing how they’re answering:

Barclays – Marginally less accommodative monetary policies may weigh on equity valuations. As a result, we expect returns on the asset class to be more muted in 2022.

Morgan Stanley – The core of our cautious 2022 view on the S&P 500 is our belief that during a mid-cycle transition, price-earnings ratios typically compress.

BNP Paribas – We expect to see some compression of price/earnings ratio multiples for the S&P 500 as rates rise.

***But Barclays offers what we believe is the answer to this, which happens to mirror Louis’ approach to the market

Back to Barclays:

Over the medium term, though, we believe a focus on quality growth companies still makes sense.

Coming into a period of sub-par returns, active management and skillful stock selection will be key.

Skillful stock selection based on quality growth companies perfectly describes Louis’ multi-decade approach to the markets.

Bottom-line, yes, “the market” could rise 40% this year as Louis suggested. But given the difference between the S&P 500 and the S&P Equal Weight, even if it does, such gains might not translate into similar gains in your portfolio.

What will matter – whether the market is up, down, or sideways – is how your specific stocks perform in a market that will be more challenging than 2021.

If you haven’t taken the time to screen your portfolio for fundamental strength as we enter 2022, I hope you’ll make time today.

Have a good evening,

Jeff Remsburg