With "Stock Valuations At Extremes" Goldman’s Clients Are Asking Just One Question
By Tyler Durden
When just ten days ago Goldman warned that over the “next few months” stocks will suffer a sharp slump, one of our more cynical reactions was that this was the all clear sign for stocks to surge to new record highs. And, in the aftermath of last week’s main event, namely the speculation that Japan would unleash helicopter money with Ben Bernanke’s blessings, they did just that. But while fading Goldman is nothing new, it happened at a very good time: indeed, the S&P 500 surged to a new record high of 2164 this week while the 10-year US Treasury yield touched an all-time low of 1.37%.
As a result Goldman, and especially its clients, are stumped. As chief equity strategist David Kostin admits, they have one burning question. As Kostin puts it, they “are struggling to reconcile how extreme valuations of both assets can co-exist.”
In defending his recently bearish calls, Kostin writes that “Risk-on has been the clear mantra since the post-Brexit low. But sentiment can reverse quickly.”
Putting the recent market move in context, Goldman says that its “year-end target remains 2100” and still expects a major swoon lower: “the path will include a 5%-10% drawdown during the next few months sparked by rising US and global political uncertainty, negative EPS revisions, decelerating buybacks, and overly-dovish policy expectations for the Fed given wage inflation trends.”
That said it appears that Goldman’s clients, at least those who listened to Kostin and shorted into last week’s rally, are getting rowdy and are countering with reasons why the rally should continue. From Kostin:
“Relatively light positioning remains the most bullish argument for tactical equity upside, in our view. . Client discussions reveal low portfolio risk coupled with concern that the rally lasts. Most investors have been skeptical of the valuation expansion and have not participated in the 8% rebound from the post-Brexit low on June 27. Upside call buying has been a popular strategy to insure against upside risk.
The Goldman strategist adds that the most common bullish argument cited by clients for a continuation of the equity rally is that low interest rates support higher stock prices. “Extended periods of falling bond yields have typically been associated with rising P/E multiples.” However, he adds, “the S&P 500 forward P/E has already expanded by 70% during the past five years, exceeding all other expansion cycles except 1984-1987 (up 111%) and 1994-1999 (up 115%). Both prior extreme P/E multiple expansion cycles ended poorly for equity investors.”
Bullish investors argue that sustained low rates will support P/E multiples of 20x or more. The Fed Model relates the earnings yield (5.7%) to the Treasury yield (1.5%). The current 420 bp yield gap is near the 10-year average. Exhibit 2 shows the sensitivity of this model. Assuming a steady bond yield, reversion to the 35-year average gap of 250 bp implies a S&P 500 year-end level of 3075 while the 5-year average gap implies 1900.
So are stocks going to 3,190, or even stayin at …read more
Source: With "Stock Valuations At Extremes" Goldman’s Clients Are Asking Just One Question
