The first half of 2021 was great for S&P 500 buy-and-holders, with every sector climbing towards all-time highs. Yet, there are problems underneath the hood of the markets and a prominent bank’s analysts are sending a near-term caution signal.
According to analysts at Bank of America, the “Wall St boom/bubble” could use a “breather.” As a result, the market is anticipating a pre-emptive slowdown in the third quarter as investors fearing the “five P’s” pull back across asset classes.
In their view, these five factors are set to weigh on investors’ returns in Q3, partially in expectation of weaker company earnings relative to growth in the fourth quarter.
In other words, stocks could fall as investor jitters make lower Q4 profits show up in current, third-quarter share prices.
So, what exactly are the 5 P’s?
The first P is the most obvious one: Pandemic. Covid-19 cases around the world are rising with the spread of the Delta variant, and Bank of America analysts are bracing for growth and earnings expectations for this year and next to decline. That, in turn, could lead to downward pressure on large-cap stock prices.
Next is a factor that I’ve mentioned a number of times in previous articles: Price. Expectations are sky-high as the investing community has already, by and large, priced in a full recovery from the Covid-19 crisis.
As you can see in the chart shown above, the S&P 500 price-to-earnings ratio is quickly approaching dot-com bubble levels. Currently, it’s 93% (more than two standard deviations) above the historical average for the S&P 500’s P/E ratio.
The third P is one that you might not expect: Positioning. The Bank of America analysts cited survey data showing fund managers pouring money into late-cycle assets, which are best suited for inflation and weak growth.
In Q3, the analysts see the S&P 500 falling below 4,000, which would represent a decline of roughly 8% from current levels. The correction would be led by tech stocks, which some investors might view as a good defensive option but many technology stocks have unjustifiable valuations.
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This next P is about the havoc that the government and Federal Reserve have wreaked on the economy: Policy. Fast-rising inflation will force governments and central banks to ease up on stimulus measures in the coming quarter, if the Bank of America analysts are right in their outlook.
We’re already seeing this retrenchment happening today, as prospects for Joe Biden’s proposed $1.7 trillion infrastructure package have dimmed as the administration now pursues a slimmed-down bipartisan deal.
Moreover, China is still a “wild card” in terms of policy, the Bank of America analysts said, but China’s central bank seems wary of overheating the country’s fragile financial sector.
The final P is Profits, and this represents a confluence of factors that could conspire to put pressure on asset prices over the coming months.
Another wave of Covid-19 restrictions, supply shortages, and growth deceleration could put negative pressure on corporate profits in the second half of the year.
Plus, Bank of America analysts are considering that stocks could fall pre-emptively as investor jitters make lower Q4 profits show up in Q3 share prices.
So, there you have it, the five P’s that could wreck the S&P 500 sooner rather than later. To that, I’d like to add a couple of P’s of my own.
First of all, P should stand for Preparation. The time to take action is now; running for the exits will be impossible when the pandemonium has already started.
And then there’s P for Precious metals. Gold and silver should have a permanent place in any informed investor’s portfolio – and if the analysts are right about Q3, then preserving your wealth could depend on what hard assets you’re holding, and how much.
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