“Despite” is a word that gets bandied about quite a bit these days.
For example: US equities managed to rise a third week despite escalating geopolitical tensions and seemingly intractable gridlock inside the Beltway.
Or, perhaps more poignant: the S&P briefly topped its record closing high from February despite concerns that the economic fallout from the worst public health crisis in a century is far from over as the US death toll mounts and Main Street disintegrates.
For their part, Goldman employs the word in the course of lifting their target for the S&P. “[We’re] raising our S&P 500 year-end 2020 target to 3,600 reflecting a 7% return despite election uncertainty”, the bank’s David Kostin says.
He then takes you on a brief trip down memory lane. When the S&P was last at current levels, “the world was in a far distant place”, he writes, adding the following,
Back to the future. Six months ago, on February 19th, the S&P 500 Index reached an all-time high of 3386. US GDP was expected to grow by an average of 2.1% in 2020. Both the fed funds rate and the 10-year US Treasury yield equaled 1.6%. Consensus 2020 and 2021 EPS estimates for the S&P 500 were $176 and $196, implying 1-year and 2-year forward P/E multiples of 17.3x and 15.8x, respectively. Then, the coronavirus hit. The world stopped. Economies froze. The S&P 500 plunged by 34% in 23 trading days. More than 20 million people globally and 5 million individuals in the US contracted COVID-19. Tragically, more than 750,000 people worldwide have died of the virus, including 167,000 in the US. The Fed cut the funds rate to near-zero. Congress opened the fiscal spigot and implemented a variety of income-replacement policies designed to help individuals and businesses bridge to the other side of the pandemic.
Yes, that sounds vaguely familiar.
Kostin goes on to call it “remarkable” that the S&P has recouped the entirety of its pandemic plunge, noting that out of the 51% rally, 14 percentage points came courtesy of the FAAMG cohort.
Generally speaking, Goldman’s take on the economy is optimistic. Earlier this month, for example, the bank said upside calls may be attractive given the distinct possibility that their optimistic growth case tied to an early vaccine is realized.
Read more: Goldman Says ‘Early Vaccine’ May Change Market Zeitgeist
The bank is looking for the US economy to rebound 6.4% in 2021 after a projected 5% contraction this year. That is easily above consensus, which sees just 3.9% growth next year for the world’s largest economy.
Goldman’s upbeat forecast is based in part on the assumption that “at least one vaccine will be approved by the end of 2020 and will be widely distributed in the US by mid-year 2021”, the bank reminds you.
The bank’s EPS estimate for next year is $170, above consensus, but as documented here, they acknowledge that the rebound will be uneven across sectors.
Equity prices are, of course, about more than just projected earnings. “The rate at which those earnings are discounted to present value” matters quite a bit, and “a plunging risk-free rate partially explains why equities have performed so well despite downward revisions”, Kostin writes.
He then notes that with breakevens now unchanged, the entirety of the 90 bp decline in nominal 10-year US yields from the February S&P highs is down to real rates.
That is the same discussion from “Picture Perfect: The Fed Gets ‘Exactly What It Wants’”. In that linked June piece, I wrote that the divergence between real yields and breakevens, and equities’ lockstep rise with the latter, are precisely what the Fed wanted to engineer, even if officials would invariably contend the rebound in stocks is a secondary concern. “The Fed must be happy”, TD’s Priya Misra said at the time. “Well, at least pleased that the market has heard them”.
Fast forward nearly two months and equities have reclaimed the highs.
Goldman’s Kostin continues. “The risk premium for US equities is likely to decline by year-end 2020 (to 5.7%) and during the first half of 2021 (to 5.2%)”, he says, adding that “a fall in ERP will be partially offset by a rise in bond yields but the combination will ultimately boost the S&P 500 to 3,600 by year-end (+7%) and to 3,800 (+6%) in 12-months’ time”.
The table (above) shows you the assumptions Goldman uses. There are, of course, a number of caveats, not least of which is uncertainty surrounding what is sure to be a contentious election.
While Goldman’s new forecast calls for “just” 7% further upside to year-end for stocks, Kostin admits that the new target represents a marked change from the bank’s previous base case. Specifically, it is 20% higher.
“In February 2020, the S&P 500 traded on a FY2 P/E multiple of 17x consensus 2021 EPS [while] today, the market trades at 20x consensus 2021 EPS”, he says. “Our year-end target of 3,600 implies a P/E multiple of 21x our 2021 EPS estimate”.
There will doubtlessly be those who will compare the new year-end target to the bank’s mid-March warning that the S&P could fall as low as 2,000 (or 1,700 based on the experiences during other recent recessions).
“Precision is difficult in a volatile market with daily price swings of +/-5% and a VIX level of 75”, Kostin wrote on March 13. “A combination of tools suggests the S&P 500 could trough around 2,000”, he said, at the time.
But, to quote from his latest, “the world was in a far distant place [then] compared with today”.
The eventual announcement of a vaccine, likely from an Operation Warp Speed locale like the Oval Office or the Rose Garden, will be the worse kept secret in stock market history. Stocks will rally on the rumors right up into the actual announcement, and perhaps even shortly thereafter. But then the reality of the mess we are still in — the deficit, lost jobs, diplomacy — will set in. That’s when the real bear market arrives.
Per your article, what does GS think happens when the economy grows 6%+ next year to interest rates? At the very least you get an extreme curve steepener- what is the second order effects for stocks? If they are correct, you have to think the 10 yr yield is up 100bps and mortgage rates up 75 bps, not to mention all the other rates. I would chalk this one up to magical thinking myself. They have modeled a world where everything goes right- I would like to know what the odds of that are? (1/4 tops right?). A more realistic and probable scenario involves a choppy recovery (50%?)- sometimes it would appear the Goldy guys are right, but I would bet against happy talk this fall. There is also a 1/4 chance things get worse well into next year- no vaccine for awhile and disease spikes in different places and different times around the country.
The coming election won’t simply be “contentious”, it will be FUBAR.
I think that risk off sentiment is likely to rise significantly with the approach of November. Positive developments regarding the pandemic may help offset market jitters to some extent even as social and political tensions mount. However, should Trump effectively ‘engineer’ a second term for himself, instability and unrest are likely to become permanent features of the socio-political landscape of the United States.
Some good points there Tom. Equally worrisome is that the incumbent loses but throws enough “I was robbed by the Comet Pizza cabal” that we suffer large-scale unrest from Trump’s base.
Based strictly on anecdotal evidence, much of the b increase in gun sales may be to center-left wing citizens rightfully alarmed by Trump’s base. I’ve been surprised how many acquaintances are finally arming up.
The Trump base had better work to increase the number of charging stations for their scooters.
Why? As Hitler learned during the eastern campaign, if an army outruns their logistics, their assault will grind to a halt.
Roll out those scooter chargers!
To offer a little contextualization, the last time there was a remotely similar setup, in 2008 during the GFC, Goldman’s chief forecaster ended up being too bullish by about 80%. Which to me suggests their forecast now ought to come with something like a 50% confidence interval, taken for what is worth but perhaps no better than a random guess. It may be unfair to single them out, but they do occupy a particular position in the know-it-all class and Professor H has created a haven for scepticism. https://www.reuters.com/article/us-financial-summit-cohen-record/goldmans-abby-cohen-defends-her-forecast-record-idUSTRE55I5OK20090619
I mean, it’s always just a guess in any given year.
And 30 million unemployed just don’t matter.
As investors, in every cycle, we typically internalise a couple of truisms that turn out to be anything but. For the past several months, the market has been convinced that the economic crisis will end (or at least see the beginning of the end) when a vaccine becomes available.
But if large swathes of the US remain unconvinced of the safety of the MMR jab, a vaccine that has been routinely administered for almost 50 years, how many are going to be convinced by a new vaccine that has been rushed through in a matter of months? I’m generally pretty scathing about the anti-Vaxxer crowd, but even I’d want to think twice before signing up.
It seems to me the markets are undergoing a frog cooking exercise. When the frog will be recognized as dead is anybody’s guess.