Over the past week, Goldman has had “a wide-ranging set of phone conversations and Zoom video meetings with clients across the investor spectrum”, the bank’s David Kostin writes, in a note dated Friday. The Zoom reference is an apparent nod to the notion that things are still far from normal.
The first thing the bank learned from these discussions with mutual funds, pension funds, insurance companies, sovereign wealth funds, family offices, and hedge funds hailing from around the world is that “the rally is unloved”.
Long-only managers are obviously “pleased”, Kostin says, but with nearly two-thirds of mutual funds trailing benchmarks over the course of the surge, long/short funds managing just an 8% return over the period, and macro funds barely treading water (returning just 1% since late March), there’s palpable frustration in some corners.
“CIOs expressed varying degrees of concern about how swiftly the market rebounded from its low, the current level of valuation, and the forward return potential”, Goldman writes. If you’ve been paying attention to the financial media, you’ve heard some of those concerns voiced by the likes of Scott Minerd, for example.
Amid the bounce, many investor cohorts have simply refused to participate. That lack of re-risking is reflected in Goldman’s sentiment indicator, which now reads -1.3, not too far from levels seen at the lows.
(Goldman)
As Kostin puts it, “the ‘fear of missing out’ best describes the thought process of many investors [and] a few fund managers also expressed the view that upside tail risk exists if further medical progress is made on the antiviral and vaccine front”.
Here again we see the psychological tug-of-war or, if you’re responsible for P/L, it’s probably more aptly described as “mental anguish”. Although we’re probably just one “Tariff Man” tweet away from another nauseating swoon, the Gilead saga shows it doesn’t take much in the way of medical “breakthrough” news to send shares surging – especially once CTAs get sucked in as key levels are breached.
Further skepticism stems from the narrow breadth of the rally. This is something Goldman has been keen to emphasize over the past several weeks. The titans (Facebook, Google, Amazon, Apple and Microsoft) now account for 21% of S&P 500 market cap. If you think top-heavy markets are a problem, you may be concerned about the current level of concentration and the assumed lack of upside for the behemoths.
(Goldman)
Moreover, valuation has become a rallying cry for skeptics of… well, for skeptics of the rally.
Earnings have, of course, collapsed, and admittedly, there’s something absurd about chasing stocks in an environment where the outlook for corporate profits is the most indeterminate it’s ever been. That could well be another factor keeping some folks gun shy.
(Goldman)
When earnings dispersion is elevated, forward multiples are typically low, reflecting the uncertainty. But not today, folks. Not today.
“Equities are either betting on a record short recession (despite forecasts for near the worst in history), or on the Fed buying equities, believing fundamentals don’t matter”, BofA wrote, in a note documenting elevated multiples in the face of depression-like economic figures.
“There may be a time to co-invest in equities with the Fed, but it will surely be at lower prices”, the bank went on to say.
Weighing in, Goldman notes that their baseline forecast for S&P 500 earnings in 2021 is $170, a figure that “optimistically assumes the US economy gradually recovers during 2H 2020 and next year posts earnings 3% above 2019”. Their downside case is $115, which would correspond to “a slower path of resumption” for economic activity.
Ultimately, Kostin writes that at 2930, the S&P now trades “at 19.5x the BUY-side estimate of EPS, the highest level since 2002”. Things look a little better if you use Goldman’s $170 estimate for next year’s profits. In that case, stocks are trading at “just” 17x.
(Goldman)
If, however, you use Goldman’s downside estimate for next year’s earnings, the S&P is the most expensive in modern history (see the grey scenario above).
Again, it all depends on how things shake out. And on that front, I’d simply remind you that even the “oracles” and Magic 8 balls are out of answers.
I wish someone would look at the PE of the S&P ex FAAMG since they are 21% of the market. I wonder what the remaining companies’ PEs average?
Other recent article addressed this question. The PE for two year forward FAANG was estimated to be 27. An assumed earnings growth of 13% was indicated. Obviously using a projected growth rate of 13% under these conditions could be seen as optimistic. Best case is two year forward of PE=27 and higher stock prices to reflect continued bubble. Worst case? Well even the $115 above may be optimistic at the nadir. This would indicate prices near to the recent low, however with no overshoot.
Check out Figure 3.
https://www.yardeni.com/pub/yardenifangoverview.pdf
The good news for now is that POTUS is taking a lions share of the credit disbursing money congress appropriated
and calling it “his” farm aide. I guess he can holster the tariff gun for a breather. Have to see how it gets spun today.
One should hope for an appropriate ass kissing by FOX.
Distributing aid based on political favors is not only unethical but more likely than not to fail in it’s aim to bolster the economy. POTUS cannot help but squander every opportunity to save himself. I see why he is the bankruptcy king, his impulses are risky to the extreme.
Current positioning leads me to conclude there will be some capitulation into buying the rally soon, S&P at 3000 sometime in the next couple week seems inevitable. The recent move up feels a lot like the move to highs into February 19, it might unravel fast after options expiry next Friday, that would make sense, which probably means it will not happen…
lol
What should stocks trade at in today’s environment? Just glancing at the top 50 companies in the S&P, most of them have great balance sheets and should weather the storm with ease so any default risk is low. The fed has completely suppressed any liquidity risk premium in assets. Risk free rates are laughably low. Is there earnings uncertainty, absolutely. But with rates as low as they are, liquidity risk gone, and low default risk, we can look further out than ever before for future earnings to still meaningfully contribute to present value of cash flows. You remove regulatory risk and you can see why anything ESG looks bubbly based on traditional metrics, but maybe things aren’t that overvalued given the the suppression of equity risk premium leading to ultra low discount rates.
Also, the US has arguably the most robust and innovative biopharma industry in the world thanks to our exuberant healthcare costs. There are real reasons to be optimistic. Remdesivir is a great start, there’s more antivirals in the pipeline which should help the supply strain. Monoclonal antibody drugs look really promising. There’s some interesting research with stem cells (healthy skepticism is warranted with these) to help against ARDS and cytokine release syndrome. There are so many others in the pipeline too. Drug/vaccine discover is being completely revolutionized thanks to big data and AI increasing success probabilities and time to success.
Everyday the state/local governments and the private sector continue to ramp testing. Just got another fast, cheaper, less invasive test with Quidels new antigen test.
There is real evidence that warm sunny weather helps reduce the spread, and combined with adequate social distancing, should help reduce the risk of large case spikes that lead to hospital capacity issues.
In times like this, drug development/testing ramp can seem slow and frustrating, but we are getting there. Everyday, we’re getting closer. And for all these reasons, buying stocks seems reasonable right here. The only reason I am hesitant at all is the administrations incompetence and the senate GOP’s “wait and see” approach.
That and the fact that a large percentage of people in general don’t understand the importance of wearing masks. A lot of young people don’t know how to use a tape measure so it’s not surprising that they can’t tell the difference between 4 feet and 6 feet. (1 and 1/3 m verses 2 m). I’m guessing a rebound in covid cases is on it’s way.
Readers and pundits should check their history books. Valuation measures at the depth of recessions are next to useless. Because of implied earnings collapse, stocks are always overvalued vs earnings at market bottoms. Obviously, sometimes more than others. The other caveat is multiples are related to risk free rate, with the latter in the sewer higher than historical PE ratios are justified.