The new year is anticipated to usher in the distribution of a COVID-19 vaccine and a new presidential administration with a split Congress, alongside an extension of this year’s improving economic activity and low interest rates. Many analysts have cited this medley of events as fuel for another rise in equities.
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Here’s a look at where strategists expect the S&P 500 (^GSPC) will land by the end of 2021.
Deutsche Bank (Target: 3,950; EPS: $194): ‘A gradual correction of overvaluation’
Much of 2020’s run-up in the stock market came with multiples expansion, as prices escalated despite a drop in earnings, as companies dealt with fallout due to the coronavirus pandemic.
Next year, as the economy recovers and a vaccine allows for long-lasting re-openings, earnings growth will rebound and multiples will de-rate, according to Deutsche Bank strategist Binky Chadha.
“The pattern of the equity market recovery, bottoming halfway through recession and recouping most of its losses before it’s over, has been typical but the continued run-up means valuations are high,” he said in a note. “In our reading, elevated multiples reflect increased participation of retail investors which we see as sustaining, but we expect the multiple to begin to de-rate.”
By Chadha’s calculation, the S&P 500’s current price-earnings multiple reflects an expensive stock market: Including Deutsche Banks’s annualized fourth-quarter earnings forecast, the S&P 500’s price-earnings multiple is at 22x, or about 5 multiple points above what the firm considers fair value.
For 2021, a recovery in earnings — which essentially increases the denominator of the price-earnings ratio — should lower multiples. That said, an increase in companies’ payout ratios as dividends and buybacks return could at least partially offset this, he added.
“A gradual correction of overvaluation argues for the the current overvaluation of 5 multiple points to diminish but remain significant at 3.6 points, putting the end-2021 multiple at 20.5x,” Chadha said.
His S&P 500 price target of 3,950 implies about 8% appreciation from closing prices on December 1.