Put the U.S. stock market pullback in perspective


It’s not a surprise the market has cooled. While there may be more volatility due to many headwinds, we think the bull market can ultimately regroup.


Kelly Bogdanova
Vice President, Portfolio Analyst
Portfolio Advisory Group – U.S.

The mood of the U.S. equity market has shifted lately from that of a charging bull to a resting bull.

The S&P 500 surged 103 percent from the COVID-19 low back in March 2020 through early Sept. 2021. This is by far the most powerful post-trough rally of all recovery periods during similar time frames going back to the 1960s. The next-best results were 61–62 percent rallies in 2009, 1982, and 1974.

The U.S. market has come a long way in a short time
S&P 500 level since January 2020

The chart shows that the level of the S&P 500 has risen from a low of 2,237 in March 2020, which was the height of the COVID-19 scare, to almost 4,537 in early September 2021, which is a gain of 103%. This has been the most powerful post-trough rally of all recovery periods going back to the 1960s.

The most powerful post-trough rally of all recovery periods going back to the 1960s – 103% gain from the March 2020 low through the early-September 2021 peak.

Source – RBC Wealth Management, Bloomberg; data through 9/30/21

Recently, the index has cooled off, pulling back 5.1 percent since Sept. 2, and has broken a seven-month winning streak while facing numerous headwinds, some of which are unique to the pandemic:

  • Persistent COVID-related distortions on supply chains, energy prices, inflation, the labor market, and overall economic momentum;
  • A number of Q3 earnings missteps and warnings due to the above issues by companies in a wide range of economically-sensitive (cyclical) industries;
  • Angst about legislation in Washington on the debt ceiling, two large spending bills, and potential tax hikes on corporations and upper-income individuals;
  • Jitters about Chinese GDP growth related to electricity rationing (including on the all-important industrial sector) caused by high coal prices and other factors, and lingering Evergrande and property market risks;
  • The Fed’s likely forthcoming policy shift to begin tapering asset purchases later this year, and the anticipation of rate hikes further out.

We think the market can ultimately work through these challenges—leading economic indicators are still flashing favorable signals—but there could be more volatility in coming weeks and months.

Washington wrangling

We don’t want to seem dismissive about the debt ceiling—it’s a real head-scratcher for a number of reasons, and the mounting federal debt continues to give us pause. Nevertheless, RBC Capital Markets, LLC’s Chief U.S. Economist Tom Porcelli expects it to play out the way it has in the past. Drama should persist in the near term, and then he thinks Congress will agree to raise the debt ceiling in a timely manner such that it averts a self-inflicted crisis.

While political maneuvering surrounding the very large $1 trillion infrastructure and $3.5 trillion budget bills continues to generate headlines, Porcelli does not believe their passage would materially boost economic growth. The total spending would likely be lower than the proposed amount, it would be spread out over many years, and potential corporate tax hikes could offset at least some of the stimulus. Lori Calvasina, head of U.S. equity strategy at RBC Capital Markets, LLC, says institutional investors (portfolio managers of mutual funds, pension funds, and hedge funds) view these bills as “show me” stories. Some companies would benefit from the infrastructure and/or green energy spending provisions, but the bills are not being seen as meaningful catalysts for overall earnings growth or the market.

Calvasina thinks the impact of a moderate corporate tax hike, such as raising the statutory rate from 21 percent to 25 percent (the consensus view), is largely factored into the market. While a hike of this magnitude is not yet officially reflected in the bottom-up consensus forecasts of analysts for 2022 and 2023, she believes institutional investors have generally built it into their earnings forecasts.

Chain reactions

Supply chain issues are taking their toll, and have likely constrained Q3 economic and earnings growth. In terms of the market, Calvasina says a key problem is all of the uncertainty associated with this issue at the industry and company levels. The mounting number of Q3 earnings warnings is a signal that some management teams are having a difficult time coping with supply chain constraints, and institutional investors are becoming more skeptical about what management teams are actually saying about these challenges. Also, institutional investors don’t have a clear sense about what will improve the situation or when it will happen. Calvasina expects supply chain pressures to recede as the COVID-19 pandemic loosens its grip, but she points out this is not a silver bullet, as other factors are at play.

At the very least, we expect more market volatility leading up to or during the Q3 earnings season due to headwinds related to supply chains, high energy input costs, inflation, and labor market constraints. It would not be surprising to us if the earnings beat rate falls short of the lofty levels achieved in the five preceding quarters and is punctuated by some high-profile earnings misses. The good news is that even those management teams that are struggling with supply chain challenges are still positive about customer demand.

More important than Q3 earnings trends is the longer-term path of earnings growth. Calvasina recently raised her S&P 500 annual earnings estimates, and has incorporated the corporate tax hike scenario. If her 2022 earnings level is achieved, it would translate to 11 percent year-over-year growth without a corporate tax hike or 5.5 percent growth with the hike—not bad, in our view, considering this would come on top of the estimated 43 percent surge in earnings this year. Overall, Calvasina characterizes her new estimates as “conservative” and notes the potential for upside if corporate stock buybacks exceed her current expectations.

RBC Capital Markets has raised estimates, and is factoring in the possibility of a tax hike
RBC’s annual EPS estimates for the S&P 500 versus consensus estimates

The chart shows RBC Capital Markets’ previous and current estimates of S&P 500 annual earnings per share (EPS) for 2021, 2022, and 2023 compared to consensus estimates. Old RBC estimates (July 2021): $192, $216, (no estimate). New RBC estimates assuming no corporate tax hike: $200, $222, $238. New RBC estimates assuming a corporate tax hike from 21% to 25% beginning in 2022: $200, $211, $226. Consensus estimates: $201, $220, $236.

Old RBC estimates (published in July)

New RBC estimates (assumes no corporate tax hike)

New RBC estimates (assumes corporate tax hike*)

Consensus estimates

* Assumes a corporate tax hike of four percentage points, which would take the statutory rate from 21% to 25% beginning in 2022.

Source – RBC Capital Markets U.S. Equity Strategy; consensus estimates are Refinitiv I/B/E/S bottom-up data as of 9/24/21

Structural support

It’s not unusual for the market to take a much-needed rest following a strong run, especially after earnings growth peaks on a year-over-year basis—which we think occurred in the second quarter of this year.

Despite the unique COVID-related headwinds, leading economic indicators are still signaling that recession risks are nearly nonexistent, household fundamentals remain strong, and earnings growth should persist, at least at a moderate pace. Therefore, we continue to anticipate worthwhile market gains over the next 12 months, albeit with less robust returns than during the last 12 months.

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Kelly Bogdanova

Vice President, Portfolio Analyst
Portfolio Advisory Group – U.S.

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