Is The Exuberance Rational This Time Around?
Just when you thought it might be time for stocks to pull back and for traders to perhaps rethink the low-volatility, steady march higher, the major indices blasted to fresh all-time highs yesterday. Just when you thought tax reform (or a lack thereof) and/or the political problems in Germany might become actual problems, traders decided to jump all over the buy buttons. And just when you thought that valuations in the high yield space might spill over into equities, even the beleaguered small- and mid-cap indices made a break for the border – and an impressive one at that.
So what gives? Why has the market mood flipped from worry to celebration? While we can never know for sure, it looks to me like the market narrative may be changing in a good way. And a little company named Goldman Sachs appears to have had a hand in the move.
You see, Goldman’s chief market strategist, David Kostin, has gone from being fairly cautious on his outlook for the U.S. stock market to something he’s calling “Rational Exuberance.”
Up until this week, Goldman’s year-end target for the S&P 500 stood at just 2400 – or about 7.7% lower than the venerable blue chip index closed Tuesday. And this is before the traditional year-end rally/window-dressing period to come. Oops.
But in a report to clients this week, Kostin suggested that there is plenty of room for stocks to run in the current environment. Assuming that tax reform passes and the economy doesn’t tank, that is.
Kostin writes, “Rational exuberance best describes our forecast for the trajectory of the S&P 500 during the next several years. Earnings drive stocks over time and should support the index rising to 2850 at year-end 2018, 3000 at the end of 2019, and 3100 by the close of 2020, representing a price gain during the next three years of 20%. Our price targets imply a modest expansion in forward P/E multiple to 18.2x at year-end 2018, a flat multiple in 2019, and a contraction to 18.1x in 2020.”
According to Kostin, “rational exuberance” is defined by “above-trend US and global economic growth, low inflation, low albeit slowly rising interest rates, and underlying corporate profits boosted by pending corporate tax reform likely to be adopted by early next year.”
In other words, Goldman believes the market’s fundamentals are going to continue to improve, something that the recent economic reports seem to bear out.
For example, First Trust’s Brian Wesbury opined in this week’s economic missive that “the economy is accelerating.” Here’s an excerpt from the report:
We’ve called it a “Plow Horse” economy, which was our metaphor invented to counter forecasters who said slow growth meant a recession was on its way. A Plow Horse is always slow, but that slowness hides underlying strength – it was never going to slip and fall. Now, the economy is accelerating.
Halfway through the fourth quarter, monthly data releases show real GDP growing at a 3%+ annual rate. If that holds, it would make for three consecutive quarters of growth at 3% or higher. Believe it or not, the last time that happened was 2004.
Last week saw retail sales, industrial production, and housing starts all come in better than expected for October, the latter two substantially better.
And while retail sales grew “just” 0.2% in October, that came on the back of a 1.9% surge in September. Overall sales, and those excluding volatile components like autos, gas and building materials, all signal a robust consumer.
The WSJ.com also chimed in on the subject this week. The following was part of Monday’s “Breakfast Briefing”:
Projections for U.S. economic growth from two Federal Reserve banks have risen in recent weeks. The Federal Reserve Bank of New York on Friday forecast that gross domestic product will rise 3.8% in the fourth quarter, up from a forecast of 3.2% a week earlier.
A separate measure from the Federal Reserve Bank of Atlanta forecast 3.4% growth last week. Research firm DataTrek noted that the rival forecasts are outpacing projections from human economists, who on average expect 2.7% growth for the quarter.
Even if the less optimistic Atlanta Fed model is correct, it would be the best quarter for the U.S. economy in more than three years.
Next, let’s toss in the better than expected readings from the likes of the Conference Board’s LEI. In October, the Index of Leading Economic Indicators surged 1.2%, which was well above the consensus estimate for a gain of 0.9% and was the biggest increase since December 2010. Additionally, the previous month was revised up to +0.1% from -0.2%. Oh, and nine of the ten LEI components made positive contributions to the index.
I know, I know, this is REALLY geeky stuff. And for that I apologize. But when you start to see this type of confluence of positive inputs on the economic front, it is hard for market geeks like me to curb their enthusiasm.
Here’s the bottom line. Unless the folks in Washington manage to screw up royally between now and the end of the year on the tax reform front, all of this positive fundamental stuff could continue to move the needle on the market’s exuberance scale.
Here’s hoping that things stay “rational” instead of getting out of hand. But then again, that never happens on Wall Street, right?
Finally, it is my sincere hope that everyone enjoys a wonderful Thanksgiving holiday. See you next week.
Thought For The Day:
He has not learned the lesson of life who does not every day surmount a fear. -Ralph Waldo Emerson
Current Market Drivers
We strive to identify the driving forces behind the market action on a daily basis. The thinking is that if we can understand why stocks are doing what they are doing on a short-term basis; we are not likely to be surprised/blind-sided by a big move. Listed below are what we believe to be the driving forces of the current market (Listed in order of importance).
1. The State of Tax Reform
2. The State of the Earnings Season
3. The State of the Economy
Wishing you green screens and all the best for a great day,
David D. Moenning
Chief Investment Officer
Sowell Management Services
Disclosure: At the time of publication, Mr. Moenning and/or Sowell Management Services held long positions in the following securities mentioned: none. Note that positions may change at any time.
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