Risk Managed Strategy Funds


Federated: Correction Odds Rising But Long-term Outlook Staying Strong

September 15, 2021
A near-term pullback could represent an opportunity for long-term investors.

Despite increasing prospects for a near-term pullback, we remain constructive on the equity markets longer term. In fact, we recently raised our S&P 500 targets to 4,800 for year-end and 5,300 for 2022 from our longstanding 4,500 and 5,000, respectively. After a spectacular Q2 reporting season, earnings forecasts continue to climb, margins are holding up and the economy—even as it appears to be slowing—is still churning out historically robust nominal growth. To be sure, we are less optimistic about the coming weeks, with a 5-10% correction looking increasingly likely into October. If that comes to pass, we believe it will represent a good opportunity for investors to reload, particularly on the more cyclical stocks in the Financials, Energy, Materials and Transports sectors.

Potential sources of a near-term correction include:

  • Reopening delay The delta variant’s spread, as well as accompanying restrictions and renewed Covid fears, have stifled some activity in high-touch service industries such as restaurants and travel, and in certain areas of the country. Many corporations have put off fully reopening, and corporate travel has not picked up the baton from the summer tourism season as had been expected. This should lead to softer growth in GDP and earnings in Q3.
  • Animal spirits calming down The psychological uplift so evident with the initial reopening of the economy in late spring and early summer faded somewhat amid lagging vaccinations and delta’s spread later in summer. While vaccinations have picked up again and delta’s rise appears to have peaked, the mood remains suspect as we start to move into the fall.
  • Economy-killing tax-and-spend prospects rising While final figures are up in the air, the bipartisan $1 trillion “hard” infrastructure package and trillions in “soft” infrastructure and tax increases that Dems are attempting to pass on their own appear on track despite protestations from moderates. The market isn’t expecting Biden to get all or most of what he wants—$4-4.5 trillion in spending and tax increases.
  • Fed tapering soon Chair Powell and other Fed policymakers, as well as other central banks, are sending their clearest signals yet that they soon will begin paring their asset purchases due to rising inflationary pressures. If yields move higher, Technology stocks that have had an outsized impact on the market and acted as defensives of late could get hit as their valuations reset.

Reasons we are sticking with our more optimistic year-end and 2022 market forecasts:

  • “When,” not “if” The economic reacceleration we’ve been expecting, though delayed by the delta variant, is coming soon—it’s a matter of “when,’’ not “if.” The economy’s fundamentals remain strong—the issues tend to be issues of supply, not demand—and prospects of a recession seem distant.
  • Global economy playing catchup The global economy has lagged the U.S. recovery due to slower vaccine rollouts. As those programs gain traction, and in some cases move ahead of the U.S., the reopening trade of Europe, Asia and the emerging markets could fire off like sequential rocket boosters starting this fall and carrying through much of 2022.
  • Earnings remain healthy and growing While earnings growth is slowing, the level of earnings continues to expand mightily. We’ve recently upgraded our 2022 and 2023 S&P earnings forecasts to $230 and $250, respectively.

The reality is this market’s run without a pullback of even 5% since last October is unusual, if not unhealthy. A sell-off could shake off frothiness and weaklings that invariably arise during such runs (although this market has seen various sectors and styles reprice even as the broader market kept rising). What goes on in Washington and the economy over the next few weeks could well be catalysts for such a move, as could a possible decision by the Fed to accelerate tapering. If any of that comes to pass and the market sells off, we’d view it as an opportunity to add. We believe this secular bull is grazing and, once fed, should romp again as earnings move back to the fore and sequential rocket-boosters set off toward the end of this year and into 2022.


Source: https://www.federatedinvestors.com/insights/article/correction-odds-rising-but-long-term-outlook-staying-strong.do