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Daily roundup of research and analysis from The Globe and Mail’s market strategist Scott Barlow

Two prominent U.S. equity strategists, Goldman Sachs’ David Kostin and Morgan Stanley’s Michael Wilson, both published reports over the weekend arguing that the bulk of the market gains for 2021 are behind us.

First Mr. Kostin,

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“A rebound in S&P 500 profit margins to the previous peak of 11.6% powered 46% year/year EPS growth during 1Q, exceeding the consensus forecast of +20%. We raise our EPS estimates for 2021 by $12 to $193 (+35% annual growth) and for 2022 by $5 to $202 (+5% growth). Our 2021 EPS estimate is above consensus, but we expect negative revisions to consensus 2022 EPS of $209 as higher tax rates are incorporated into analyst models. We believe three factors will keep the forward P/E multiple unchanged at roughly 22x: Decelerating US growth, a real rate-driven rise in yields, and the likely passage of tax reform. Our 3-, 6-, and 12-month S&P 500 price targets are 4300 (+3% from today), 4300, and 4450 (+7%).”

Now Mr. Wilson, from Mid-Cycle Brings More Risk than Reward, (my emphasis)

" The rapid recovery has us entering a mid-cycle environment only 1 year in, and market internals are reflecting that — corrections in ultra high growth, small caps, low quality, and early cycle groups like Semis are sending a powerful message about the durability of COVID economy gains and the next stage for the expansion … Midcycle transitions commonly see valuation contractions of 10-20%. Risk premium compresses with excitement around recovery, but eventually higher rates, positioning resets, and a slowing rate of change in growth offset this and send multiples lower. Earnings growth in a strong economy mitigates downside, but rising costs and higher corporate taxes now limit the upside. The net effect is a tug-of-war between earnings/ valuation, tepid returns over the next 12 months, and a likely 10-20% correction between here and there … Favor Reflation (Fins/Materials, both OW[overweight]) over Reopening (prefer Staples, EW[equal weight], to Discretionary, UW[underweight], in consumer) as the former remains the primary economic/investment narrative and the latter carries high expectations with execution risks. Reasonably priced Growth and Quality offer dependable earnings power in a transition period — look to Health Care (OW) and parts of Comm. Services (EW) rather than Tech (EW). Be selective in cyclicals after a powerful run as the rate of change on growth peaks — we downgrade Industrials to EW.”

“@SBarlow_ROB GS’s Kostin more cautious ... “- (research excerpt) Twitter

" @SBarlow_ROB ... and so is Morgan’s Wilson " – (research excerpt) Twitter

***

Citi U.S. equity strategist Tobias Levkovich feels vindicated by the underperformance of technology stocks,

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“The S&P 500 IT sector has sold off near 7% since April 26th, while the S&P 400 Midcap IT performance is down more than 12% vs an 11% decline for the S&P 600 Small Cap IT index. Such weakness is much worse than the overall market’s 2% dip and illustrates the risks inherent with stretched valuation, especially in unprofitable software stocks. Plus, the drawdown was notable in semiconductor and chip equipment names… We have suggested for months that higher bond yields and inflation concerns could hurt the tech space. The notion of “stickier” inflation (driven by labor cost increases and an inability to ease supply chain bottlenecks quickly) can go beyond a few months of “transitory” impact from the base effects of pandemic-related softness last year … Valuations still seem problematic across the various Tech industry groups despite the selloff. We understand that many names have dropped 30%-40% from their highs but those declines probably reflected overly-enthusiastic stories that benefitted from price momentum enticing new investors who were anticipating that others would take them out at even higher levels. That kind of chasing the tape often does not end well. Hence, we are not buyers on weakness yet, though we admittedly have a larger cap bias since some of those companies can generate powerful EPS by limiting expenses and also can buy back lots of stock.”

“@SBarlow_ROB Levkovich takes a bit of a victory lap on tech weakness” – (research excerpt) Twitter

***

Diversion: “All the Animals American Men Think They Can Beat in a Fight and Why They Can’t” – Gizmodo

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