How to Cash in on an Epic Stock Market Rally in 2021

How to Cash in on an Epic Stock Market Rally in 2021

Posted On December 4, 2020 12:51 pm

In part one of this series, I explained why five likely events in 2021 are likely to drive an impressive rally in stocks, which can make smart investors a fortune.

Just how powerful a rally are we talking about?

“In a client note published Wednesday, Goldman said stronger-than-expected third-quarter earnings, a divided Congress that leaves little scope for major legislative changes, and the impact of the Pfizer vaccine, has allowed for an improved year-end point target of 3,700 for the S&P 500, which the bank says will be followed-up by a 16% gain in 2021 and a further 7% advance in 2022 that will take the U.S. benchmark to 4,600 points by the end of 2022.” – thestreet.com

Goldman Sachs (GS) is one of the 16 blue-chip economists, the most accurate forecasters out of 45 tracked by MarketWatch.

While I can’t tell you whether their expectations of 4,100 on the S&P 500 by the end of next year is likely, much less the 4,600 they expect by the end of 2022, here are two reasons why those predictions of a 27% rally over the next 25 months may be reasonable.

More importantly, Goldman’s note has within it the secrets to making far more impressive short-term gains, among the safest and highest quality dividend blue-chips in the world.

2021 Earnings Growth: Boom Times For Corporate America

(Source: FactSet Research)

The FactSet consensus is for 22% EPS growth next year, and the Reuters’/Refiniv consensus is similarly impressive.

While not as impressive as 22% EPS growth in 2021, Reuters’ expects almost 16% more EPS growth in 2022. That would be the two best years of earnings growth since 2018, a year when earnings grew by almost 23% thanks to corporate tax cuts. Now I should point out that Goldman’s 4,600 S&P forecast for 2022 won’t be entirely justified by this strong earnings growth bonanza.

                S&P 500 Valuation Profile (4,600 S&P 500) 

Year EPS Consensus YOY Growth Forward PE Blended PE Overvaluation (Forward PE) Overvaluation (Blended PE)
2020 $137.72 -15% 26.8 26.8 62% 58%
2021 $168.63 22% 27.3 27.0 65% 59%
2022 $195.79 16% 23.5 25.4 42% 49%
12-month forward EPS 12 Month Forward PE Historical Overvaluation PEG 20-Year Average PEG S&P 500 Dividend Yield 25-Year Average Dividend Yield
$160.09 28.7 74% 3.38 2.35 1.62% 2.05%

(Source: Dividend Kings S&P 500 Valuation & Total Return Tool) 

If the forward earnings expectations prove accurate (FactSet reports that on average analysts overestimate earnings growth by 2% to 4% per year) then 4,600 on the S&P 500 by the end of 2022 would still represent a 23.5 forward PE. That would be a 42% historically overvalued market. However, this brings us to another reason that 2021 is likely to be a great year for stocks.

Low-Interest Rates Are Likely To Persist Into Next Year

The bond market, the so-called “smart money” on Wall Street, is expecting very modest inflation for the next 30 years. This is likely to allow the Fed to make good on its plans to not raise rates through the end of 2023 at the earliest. But more important for stock prices is that long-term interest rates remaining lower for longer minimizes the risk of Moody’s “lost decade” for the S&P 500.

Moody’s base-case economic forecast is for 10-year treasury yields to start rising quickly in 2021 and keep rising all the way to 4.3% by the end of 2030. That would represent such a shock to this “there is no alternative” stock market that Moody’s base-case forecast is for the market to deliver negative returns for the next decade. Don’t get me wrong, I’m not telling you that paying 23.5X earnings for stocks is reasonable or prudent, no matter how long rates stay low. But the fact remains that as long as long-term rates don’t rise too quickly, the chances of a lost decade fall. Which brings us to the final and most important fact smart investors need to know about 2021.

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About author

Dividend Sensei
Dividend Sensei

I'm an Army veteran and former energy dividend writer for The Motley Fool. I'm a proud co-founder of Wide Moat Research, Dividend Kings, and the Intelligent Dividend Investor. My work can be found on Seeking Alpha, Dividend Kings, iREIT, and the Intelligent Dividend Investor. My goal is to help all people learn how to harness the awesome power of dividend growth investing to achieve their financial dreams and enrich their lives. With 24 years of investing experience, I've learned what works and more importantly, what doesn't, when it comes to building long-term wealth and income streams and achieving long-term financial goals.

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