The S&P 500 index set another record high on Thursday, rising more than 1% to close at 4,019, buoyed by growing optimism about economic growth.
The $1.9 trillion economic relief plan signed by President Joe Biden in March coupled with his plans to spend even more ($2.25 trillion) on infrastructure investment and the growing number of Americans vaccinated for COVID-19 underpin that optimism.
Along with that positive outlook are some growing questions about how far the rally can go and how long it can last and whether the some parts of the U.S. stock market are overvalued.
But some sectors of the stock market may have more room to run, Liz Ann Sonders, chief investment strategist at Charles Schwab, tells ThinkAdvisor.
What History and Valuations Tell Us
Nicholas Colas, co-founder of DataTrek Research, notes in his latest briefing report that it's very unusual for the S&P 500 to post double-digit gains three years in a row — it gained 31.2% and 18% in 2019 and 2020, respectively — though not unheard of. "Could that happen again with an accommodative Fed and a Democratic President and Congress pushing for more fiscal aid? Yes, as long as rates don't rise too high," writes Colas.
But he cautions that "corporate margins were already at record highs after the Trump administration's tax cuts … and the Biden administration is also now, of course, trying to raise corporate taxes."
Morningstar analyst Dave Sekera writes in his Quarter-End Insights report that the broad U.S. equity market is 3% overvalued even after accounting "for a strong economic resurgence in 2020" that carries over into 2021, but many individual stocks are not, including many value stocks, which have outperformed year to date.
Through March 26, the Morningstar U.S. Value Index surged 13.39% while its U.S. Growth Index fell 0.53%, and the firm's U.S. Small Cap Index gained 11.87% while large-cap stocks gained just 4.68%. "Value stocks should benefit from the strong economic resurgence in 2021 and 2022 … but … we no longer expect small-cap stocks to outperform."
"It's not all blue skies," write Bank of America Securities strategists, in a recent market note. "The market appears to already be pricing in additional stimulus and the focus is shifting to paying it back (i.e., higher taxes). Valuations today are signaling anemic long-term returns and rising rates are also a headwind for both income investors … and corporate margins."
But the strategists, headed by Savita Subramanian, are not recommending that investors retreat from the market. "Our work suggests staying invested is an under-appreciated way to avoid losses, and that focusing on fundamental factors over momentum/positioning factors wins over the long-term. Quality, which is cheap and neglected, is also a good hedge against volatility."
