Look, JPMorgan is out with their year-ahead outlook for equities and the bank is bullish. Imagine that.
In fact, they’re significantly more bullish than consensus which, at least as of a week or so ago, was S&P 2,800 by year-end 2018. “After two consecutive years of multiple expansion with S&P 500 PE re-rating by ~2 turns to 18x (NTM), we believe valuation will likely remain elevated and expect S&P 500 to reach 3,000 by YE 2018,” the bank writes, in a note dated Thursday.
On the off chance Raymond James strategist Andrew Adams is right to suggest that investors are prone to being fooled into thinking stocks can’t go higher because people don’t understand that if they just click and drag, they can adjust the scale on their S&P charts, here’s what JPMorgan’s target looks like:
Now you might be asking yourself the following: “how did they get 3,000?” Actually, you’re hopefully not asking yourself that because if you can’t regurgitate the consensus narrative by now, well then you aren’t paying attention. But for those who need to be reminded, here are the bullet points from the bank:
- Goldilocks scenario for equities with strong consumption (2.6%) and global IP growth (3.5%) while inflation remains moderate (1.7%).
- Fundamentals should remain supportive with ~8% annual earnings growth for next two years (excluding tax benefit).
- Tax reform should be a significant source of upside for equities and should drive strong positive earnings revisions. We estimate the tax plan could provide additional upside of ~$10 to S&P 500 EPS, which would increase our estimates to $153 in 2018 (assuming the tax plan is effective next year) and $165 in 2019.
- Cross-asset flows into US equities from developed market bonds (expected to be down in 2018) and international equities on US tax catalyst; and
- Investment activity (buybacks, dividends, M&A, and capex) should increase driven by rising profits, cash repatriation, and declining policy uncertainty.
Got that? “Goldilocks” (decent growth and inflation that’s still subdued enough to keep DM central banks from getting too aggressive with the normalization push), the free call option on earnings from tax reform, flows, and buybacks.
You already know the Goldilocks story and the tax reform push is well-worn territory in these pages. Of course we’ve talked ad nauseam about buybacks and the extent to which they’ve been supercharged by artificially suppressed borrowing costs, but it’s worth noting that JPM “expects a record $500b in net stock repurchases next year.”
Notably, 32% of announced repurchases have been financed with new debt issuance over the past 12 months:
Needless to say, that would suggest the corporate bid could fade as yields rise and equity valuations remain elevated, by JPMorgan does remind you that “stock buybacks remain overwhelmingly funded with internally generated funds rather than debt.”
As far as valuations go, the bank is leaning on the only argument that still works: relative value. When everything’s in a bubble, that’s all you’ve got. But that doesn’t change the fact that on an absolute basis, the picture looks like this:
We would reiterate that there is nothing “attractive” about that in isolation. The only way that looks any semblance of compelling is by comparison to credit and bonds where the picture has become so distorted as to be absolutely laughable.
What could go wrong, you ask? Well, for that ask the bank’s quant wizard Marko Kolanovic affectionately known across markets as “Gandalf.” To wit:
Tail Risk for equities and other risky asset classes will increase in 2018. Our analyses point to a significant impact of monetary stimulus removal on levels of risk premia across asset classes, levels of leverage and valuations. However, asset classes may not react immediately, and like a ‘frog being boiled’ tail risks may be realized with a significant delay and triggered by an unrelated catalyst. The tail risk could manifest itself with forced deleverage of systematic strategies (options hedging/dynamical delta hedging, volatility targeting, risk parity, trend following), disruptions to market liquidity, and failure of bonds to offset equity risk.
Yes, “forced deleverage of systematic strategies.” And on that note, we’ll leave you with a fun visual that gives you an idea of how that crowd is positioned:
I do not think you should really be calling the taxation changes being proposed in Washington “tax reform”. A bald face tax cut and profit expansion (via lower corporate taxes) for the rich does not merit that term.
I expect that much of the corporate tax cut will be drop-shipped to the C-Suite, then some used for dividend increases and share buybacks, with plenty left sloshing around for ill-timed and illogical M&A and general gross mismanagement, leading to the next financial crisis. But that’s just me.
It’s getting a lot warmer in the pot for us frogs. With well over a 5% inflation rate for the lowly us out in the real world and this tax scam which is right in your face, the water is heating up all the faster. A passage of this tax theft by an amoral republican congress and then it’s “Miller Time” for the gutting of all safety nets, because sooo much $$$ is wasted on real people (as in living breathing people) and nothing is wasted on our wars, corporate welfare, bank bailouts, government waste and abuse of OUR hard earned tax money.
Here is a concept, everyone fills out a legal IRS form to delay all taxes until the following April 15th. Yes, you can legally hold ALL that money owed in a bank account and not pay it until you absolutely HAVE to. Will anyone start listening then????
Me thinks JP could be right on this call. I believe I read BofA was throwing out similar numbers also. The search for yield is a powerful thing. Equities are delivering at the moment, and as Kolanovic stated, “asset classes may not react immediately” to the changing liquidity tide. Many habits have been developed over the last 8 years… habits are hard to break. Even for institutional investors.