Potential for New Federal Stimulus Reshapes 2021 Market Outlooks

The slow but steady distribution of coronavirus vaccines in the U.S. and other developed nations is also having a favorable impression on the equity markets, but serious risks remain. 

In new comments shared with PLANADVISER, Jeff Buchbinder, equity strategist for LPL Financial, says the firm has upgraded its 2021 forecast for U.S. gross domestic product (GDP) growth from between 4% and 4.5% to between 5% and 5.5%.

Though the shift may seem small, Buchbinder says, it is actually a big deal—given the huge amount of additional wealth that is represented by an increase in a multitrillion-dollar figure such as the U.S. GDP—and something long-term investors should find encouraging.

“When we first issued our U.S. GDP forecast for 2021 back in December of 2020, we did not expect additional fiscal stimulus to pass until this year,” Buchbinder explains. “Instead, it came in the form of a roughly $900 billion package passed on December 29. Nor did we anticipate another $1 trillion or more to come this spring, which is now very likely given the Democrats have control of Congress.”

Buchbinder expects the new stimulus package will become law, but it still has a lot of runway to cover before taking flight.

“Our ETA for another package at this point is late March, with the Democrats pursuing reconciliation, requiring just 51 votes in the Senate,” he explains. “Stimulus is the primary reason for the increase in our economic growth forecasts, though we are encouraged by the progress made toward ending the pandemic in recent weeks. The holiday surge in COVID-19 cases has largely passed, and new daily COVID-19 cases in the United States have fallen roughly 60% from the January 8 peak. Meanwhile, the total number of patients currently hospitalized with COVID-19 has fallen below 100,000 for the first time since early December.”

Other sources echo this point, noting that the vaccine rollout in the U.S. has picked up speed since the holidays. Encouragingly, the nation is now averaging more than 1.3 million doses of the vaccine per day, according to the Centers for Disease Control and Prevention (CDC).

“Prospects for better U.S. growth should flow through to export-driven emerging market (EM) economies, so we have slightly increased our EM GDP growth outlook as well, in addition to our global GDP forecast,” Buchbinder says. “The lockdowns and resulting deep recession from the pandemic led analysts to aggressively reduce earnings estimates last spring. Though not clear at the time, in hindsight, those cuts have proved far too draconian. Earnings estimates for 2020 and 2021 bottomed in July and have been climbing steadily ever since, suggesting S&P 500 companies may recapture their 2019 pre-pandemic earnings power before the end of this year—a truly remarkable achievement considering the challenges. … A stronger earnings outlook supports higher stock prices, in our view, so we are also raising our year-end 2021 fair value target range for the S&P 500 from between 3,850 and 3,900 to between 4,050 and 4,100.”

That new target range is based on a price-to-earnings (P/E) ratio of just below 21 times the firm’s 2022 earnings-per-share forecast of $195.

“[In conclusion,] our confidence in a full economic recovery is growing,” Buchbinder says. “The battle against COVID-19 isn’t over, unfortunately. New, more infectious variants of COVID-19 are out there. The vaccine rollout will take time, and there will be holdouts. Consumer behavior may be slower to return to normal than we might expect. We see these risks as manageable at this point and believe the market will continue to look forward to life on the other side of the pandemic.”

According to PGIM Investments’ latest “On the Minds of Advisors” quarterly survey data, published last week, the vast majority (79%) of financial professionals surveyed are optimistic about equities this year.

“Interestingly, sentiment varied by type of adviser,” the survey report explains. “Registered investment advisers [RIAs] were slightly more pessimistic than broker/dealers [B/Ds], with only 64% indicating they had a positive outlook for equities in 2021, versus 83% of broker/dealers in the national, regional, independent and bank channels.”

PGIM’s own quantitative outlook is firmly bullish on the 2021 equity markets. In its 2021 outlook, the firm notes that an “earnings revival” driven mainly by improving revenue growth and increased operating leverage is likely to support solid equity returns this year, even as elevated stock market price/earnings multiples may experience muted declines.

On the fixed income side of the equation, comments shared by Peter Yi, director of short-duration fixed income and head of taxable credit research for Northern Trust Asset Management, are also encouraging, though he says there are some issues to watch out for.

“In [the recent] Federal Open Market Committee meeting, Chairman Jerome Powell indicated that the economy is still far from where it needs to be with regards to employment and inflation,” Yi observes. “To support the broader economy and maintain accommodative financial conditions, he signaled that the Fed will continue buying government-related bonds for quite some time through quantitative easing [QE]. The fact that Powell provided little new guidance leads us to believe that the Fed has set a high bar before any thoughts of slowing down or tapering its asset purchases.”

As Yi explains, the Federal Reserve has been buying about $120 billion in Treasurys and mortgage bonds a month, keeping longer-term yields and interest rates low to support the economy.

“The proceeds from the purchases flow into bank reserves, which quickly doubled to $3.2 trillion mid-last year from the beginning of 2020,” Yi says. “At the current pace of Fed purchases, we think reserves can reach $5 trillion by year end, which would also grow the Fed’s balance sheet close to $9 trillion, from around $4 trillion prior to the pandemic.”

Yi says banks may invest the excess reserves in a variety of short-term investments, which could push money market yields lower.

“However, the Fed has tools to prevent overnight rates from falling below its policy target range by raising interest rates paid on excess reserves or with its reverse repo facility through technical adjustments,” he says. “Investors are cautious to avoid another taper tantrum like the one that occurred in 2013, when Fed officials signaled a slowdown in asset purchases, resulting in higher yields and losses for bond investors. While many market participants believe the Fed will likely begin to taper asset purchases toward the end of this year, we believe the initial taper is more likely to happen in 2022 or perhaps even 2023. It’ll take a series of inflation data above the Fed’s 2% target to demonstrate a sustainable trend. Inflation remains the most important indicator to monitor and will have the most influence in the timing of any tapering.”