With the S&P 500 up 20% this year without a single 5% pullback, how much is left in the tank?

Published Sat, Aug 28 20218:34 AM EDT

What more could an investor ask for? Stocks are having one of their best years ever in terms of gain per unit of pain, the S & P 500 up 20% not quite two-thirds of the way through 2021 without even a 5% setback along the way. The index is set up to register a seventh straight monthly gain, the first time ever achieving this from February through August, while also tracking toward three straight months of at least a 2% rise. Such three-month runs have only happened 13 times since 1990, two of them in 2021, according to Instinet. And along the way, corporate earnings have run so far ahead of expectations that the market's valuation based on current, higher forecasts is down from where it stood a year ago; the market's become less expensive the easy way. Speaking of easy, Federal Reserve officials have steered investor expectations deftly toward a start to a tapering of the Fed's $120 billion-per-month bond-buying program late this year or early next, without triggering a stress response. Chair Jerome Powell on Friday morning gestured in the direction of such a timetable if the economy stays on track, but also pushed the view that high inflation readings would recede and that tapering has no bearing on an eventual rate hike. The market nodded right along, Treasury yields easing back and stocks ripping 0.9% to a new record. Even the summer surge of the delta Covid variant, while causing an alarming bout of further human suffering, has been unable to knock the uptrend off course, arising just as investors' fears were clustered around the chances the economy would overheat. Aggressive dip-buying reflex No one would wish for it, but the market registered concern about the growth-dampening effects of soaring global Covid infections by taking down overextended cyclical and "reopening" stocks, leaning back on the all-weather growth stocks that dominate the S & P 500. Localized corrections in bank, transport, homebuilding, small-cap, energy and semiconductor stocks reset their valuations and unnerved investors just enough to keep excess enthusiasm at bay. The longer the indexes advance, the more aggressive the dip-buying reflex grows. This chart from BCA Research maps S & P 500 pullbacks from a high since 2015, showing the ever-shallower retreats since the February-March crash last year. A similar, even longer, stretch of scanty setbacks ran from late 2016 all the way through 2017, another post-election year of fiscal-policy excitement, a reflation of nominal economic growth, constant sector rotation and a predictable Fed. Such a setup has hovered at the sunny end of the probability spectrum for a while, as noted here in February : "We can't yet rule out the chance that this will be like 2017 or 2013 – the past two post-election years, when the market stayed on an upward grind and offered few chances to buy in on a sharp break." Good thing we didn't rule it out. (Note that 2013 was the year of the so-called Taper Tantrum, when markets initially bucked against the Fed's hint that it would sunset its quantitative-easing before settling into a pulsing, low-drama climb.) So even though the market's reward-to-risk ratio might feel "as good as it gets," it's not even as good as it has been as recently as four years ago. Four years later, of course, the cumulative superlatives are more extreme. The S & P at 4500 is triple the 1500 area that marked the major peaks in both 2000 and 2007. More surprising, perhaps: The index since the March 2009 bear-market bottom has gained an annualized 16.4%. That's a percentage point better than the 15.4% a year the index delivered from the October 1987 crash low through the generational top in March 2000. Those periods covered almost the exact same number of days, just over 4,500. This picture of rolling ten-year total returns for the S & P 500 over nearly a century shows the market pushing into the upper range of trailing decade-long gains. So – for real, now - what more could an investor plausibly ask of the market from here? Where to from here? From a short-term view, strong and persistent rallies tend to give way to further strength in subsequent months. Of those 13 prior three-month streaks of at least a 2% gain, none of them ended at a significant market peak. In eight of the instances, the S & P continued higher the following month, with the average one-month return of all instances 1.7%, says Instinet. The 2017 tape – that similar tenacious upward grind with minimal pullbacks – culminated in a furious fourth-quarter melt-up that carried three weeks into January 2018, creating a concurrent crescendo of price momentum, investor enthusiasm and cycle-high valuations before a severe vertical break that featured rampant bets on low volatility blowing up. That's not the only way for powerful rallies to end, but current conditions don't yet rhyme very well with that buying stampede, with sentiment not yet exuberant and the indexes not as flagrantly overbought as they were then. In terms of the long-term-returns trend, major bull market cycles have tended to end with trailing annualized ten-year gains hovering in the teens, not merely bobbing up there briefly. Which is of some comfort, perhaps, even if the forces of mean-reversion are turning less friendly for equity performance in the coming years. These are merely tendencies and precedents not a strict handicapping of the present market drivers, of course. It's tough to escape the encroaching sense of past-peak conditions across several vectors. Peak reopening acceleration, peak policy tailwinds, peak earnings growth, and probably peak credit-market generosity. None of this equates to peak equity prices, though, so long as the direction of travel for the economy is forward and for profits is higher. Profit forecasts for the third and fourth quarters are probably still a bit too low, but the typical pattern after a massive profit rebound would be for the year-ahead estimates for 2022 will start out too high, at a time when the S & P is trading at a stout 21-times forward 12-month profits. Cantor Fitzgerald head of equity derivatives and cross-asset strategy Eric Johnston last week shifted to a neutral stance on U.S. stocks from a steadfastly bullish one, his 4400 S & P target from late last year once the highest on the Street. The reasoning for the downgrade include elevated investor equity exposures, past-peak growth, September's poor historical returns and fiscal-spending drag in 2022, among other factors, which together mean not that stocks are doomed but that "the time to close your eyes and just own equities is now over." A somewhat stingier, more uneven market before too long should come as no shock to anyone, given all this and how far much ground the indexes have covered. Yet this market's surprises have come only to the upside for 17 months, while all along it was plausible to argue it had come too far, too fast.

A trader works on the floor at the New York Stock Exchange, August 27, 2021.

Source: NYSE

What more could an investor ask for?

Stocks are having one of their best years ever in terms of gain per unit of pain, the S&P 500 up 20% not quite two-thirds of the way through 2021 without even a 5% setback along the way.