Mid-cycle? Late-cycle? Nope: according to the latest note published overnight from JPMorgan head global equity strategist Dubravko Lakos-Bujas, "even though equity leadership and bonds are trading as if the global economy is entering late cycle, our research suggests the recovery is still in early-cycle and gradually transitioning towards mid-cycle." And echoing his JPM colleague and fellow Croat, Marko Kolanovic, who yesterday advised clients to stop freaking out about the delta variant (advise which markets are taking to heart today), Dubravko writes that the largest commercial bank remains "constructive on equities and see the latest round of growth and slowdown fears premature and overblown."
Elaborating on why he is sanguine about the current Delta case breakout, Lakos-Bujas writes that "we remain of the view that this latest wave will not derail the broader reopening process. While cases have gone up, deaths / hospitalizations remain low and stable due to broadening vaccination rollout and self-immunity from prior waves."
The strategist then argues that "reopening of the economy is not an event but rather a process, which in our opinion is still not priced-in, and especially not now given recent market moves. For instance, an increasing number of reopening stocks are now down 30-50% from 1Q21 highs (i.e. travel, cruise lines, oil) and some have reversed back to last year June levels when COVID-19 uncertainty and economic setup were vastly worse than today."
Given the above, JPM sees "increasingly compelling" risk/reward for the reopening theme, which can be expressed through Consumer Recovery (JPAMCONR <Index>), Domestic Recovery (JPAMCRDB <Index>) and International Recovery (JPAMCRIB <Index>) baskets, see Fig 1." Additionally, JPm argues that global mobility remains nascent and its normalization will continue to release pent-up demand, while tight inventories and new orders bode positively for global growth.
Combining all this bullishness, the JPM equity strategist is revising his EPS estimates higher by an additional $5 to $205 for 2021 and raises the bank's long-held 2021 year-end price target of 4,400 to 4,600, due to the following considerations:
At a thematic/sector level, the risk/reward for reopening stocks has improved significantly with the recent pullback creating many unusually attractive opportunities for investors to re-enter various parts of the cyclical cohort. Consumer Discretionary (i.e. Retail, Travel & Leisure), Semis, Banks and Energy are strong buys at current levels. For instance, large-cap Energy is now trading at a ~10% FCF yield and a >8% FCF/EV yield at $70 Brent in 2022, with leverage that is <1x. The sector has increasing potential for a sharp short squeeze and move higher, given its extreme disconnect from oil fundamentals (i.e. widest in 30+ years, Figure 10). In addition, our Semiconductor research argues that we are only 30-40% of the way into the current semiconductor upcycle and expect strong Y/Y growth into next year with positive EPS revisions for the next 3-4 quarters. Supply will likely remain tight into 2022, while demand remains strong (20-40% above companies’ ability to supply), thus this supply demand imbalance will persist through 2021. Although customers are responding to tight supply with higher than needed orders, ongoing supply tightness is limiting fulfillment. In fact, JPM expects channel and customer inventories to decline Q/Q again in the just completed June quarter.
Looking at the fundamentals, JPM predicts that S&P 500 gains should also be supported by strong earnings growth and capital return until 2023, and is why JPM is adjusting its above consensus S&P 500 EPS by another $5 for 2022 to $230 (consensus $214) and 2023 to $250 (consensus $233).
This revision is largely due to global reopening which is delayed and bound to release further pent-up demand, inventory replenishment, rising profitability for Energy companies, and ongoing policy actions (childcare, infrastructure, etc). We expect cumulative revenue growth of ~30% by 2023 relative to pre-COVID (FY 2019), ~150bp net income margin expansion to a record high at over 13%, and gross buybacks nearing an annual pace of ~$1t during this period.
While all sectors are expected to contribute to earnings growth, JPM expects reflation sensitive sectors (Commodities, Financials, Industrials) and Consumer to do the heaviest lifting in the coming quarters in terms of beats and revisions.
Putting it all together, Lakos-Bujas says that "considering this outlook for earnings and shareholder return, we are raising our Price Target to 4,600 for year-end 2021."
But while any first year strategist can goalseek a fundamentally bullish narrative and chart it, as JPM has done below...
... there is a very specific reason behind JPM's bullish reversal: the coming surge in buybacks which will result in a boom in shareholder returns, or as Dubravko notes, "corporates have already increased gross buybacks from pandemic era low of $525b (trailing twelve months as of 1Q21) to an annualized run rate of ~$775b YTD and should surpass previous record of ~$850b (as of 1Q19)."
In practical terms, JPM expects a sharp drop in the S&P's share count in the next 24 months as the buyback-facilitated slow-motion LBO continues.
Some more details below on the one biggest catalyst behind JPM's SPX price target hike:
Expecting a boom in shareholder return led by buybacks. Buybacks are reemerging as a key theme with net buyback activity significantly improving this year after bottoming in 2Q20. Corporate buyback announcements, typically a leading indicator of buyback execution activity and corporate confidence, have already well-exceeded 2020 levels ($431B YTD vs. $307B 2020, see Figure 25). In fact, the rebound in announcement activity is similar to the surge post-TCJA (see Figure 23) which is tracking towards and it is likely to easily surpass ~$650B by year-end and likely to see rolling 12-month announcements surpass prior record level of ~$1T. Historically, buyback announcements have been concentrated within Technology and Financials. However, YTD we are seeing strong announcement activity from Communications as well (driven by GOOGL ~$50B in Apr). As a reminder, ~$90B of Tech’s $133B in announcements YTD is supported by AAPL and ~$25B of Financials' ~$92B is supported by BAC.
With the June 30th lifting of pandemic era restriction on US Banks, we could see some further pick-up in buyback announcements. Dry powder (i.e. announced repurchase programs not yet executed) levels have been recovering to pre-pandemic levels (~$658B, see Figure 27) as executions have been relatively slower to rebound but should show a material sequential growth in the coming quarters. With record profit margins (~13% in 2022 vs ~11.5% in 2019), bloated cash levels of $2.0T ex-financials (vs. $1.6T pre- COVID), and lower high grade debt yields (JULI at 2.6% now, vs 3.3% prepandemic), we are expecting a boom in buyback activity over the next year. Gross buybacks should surpass the prior executed high of $850b.
In summary, assuming $875b in buybacks and dividend income of $575 over the next year, JPM calculates that the expected shareholder yield is 3.9%. This, as Dubravko concludes, "is a significant cross-asset valuation support for equities at a time when 10yr US bonds are yielding 1.2% and $13 trillion of global debt has a negative yield."