You heard it here first. Well, maybe 2nd as GS's Chief US Equity Strategist, David Kostin, says the U.S. economy will achieve above-trend real GDP growth in 2014, ending a six-year period of economic “stagnation.” And in developed economies, the final year of economic stagnation before GDP growth has been linked to price/earnings multiple expansions averaging 15%. They expect the S&P 500 p/e multiple will continue to rise, reaching 15 times at year-end 2013 and 16 times by the end of 2014.
“We are raising our S&P 500 dividend estimates and index return forecasts for 2013 through 2015. We expect S&P 500 index will rise by 5% from the current level to 1,750 by year-end 2013, advance by 9% to 1,900 in 2,014, and climb by 10% to 2100 in 2015.”
Goldman's timing is, of course, BRILLIANT, as it is Tuesday and the market has been up 18 Tuesdays in a row, so why stop now? 2,100 at 16x earnings is $131.25 per share so, in general, to be on that trend – we need to see 10% annual earnings increases from here ($110) but, of course, we were at $111.30 in January and earnings estimates have DROPPED to $110.10 as 2 rounds of earnings reports have come in weaker than expected so far – so you need a good supply of fairy dust to get as high as David Kostin.
To be fair to GS, they did call S&P 1,675 and yesterday the S&P was at 1,666 (the mark of the Blankfein!) but, unfortunately, they made that call in Jan of 2008 and were, in fact, off by about 744 points on December 31st of that year – and not in a good way! To be fair, in May of that year, they adjusted to 1,380, so only off 439 but the S&P was at 1,380 in May and, as you can see from the May 2008 Bespoke chart on the left, NOBODY SAW IT COMING – even when "it" was already there.
Oddly enough, on Tuesday, May 20th of 2008, I had a moment that now gives me severe deja vu, saying:
I’ve been growling for quite some time now that I want to see a real breakout before we turn bullish and, unfortunately, we could be in for a textbook reversal as we do not have the catalysts we need (falling oil, rising dollar, aid to homeowners) to push us out of a range we’ve been tracking since January 21st.
Sound familiar? Unfortunately, fundamental investors need to get used to being right too early, which is a nice way of saying wrong except that it has a happy ending (for us) – as long as we manage our portfolios for the LONG run, not the day to day and as long as we don't lose our nerve just because the rest of the herd is stampeding the other way.
That's the hardest part, you have to fight human nature and, as an analyst who talks to his readers, you have to be willing to take a stand – even when it's an unpopular one. If 2008 taught me anything it's NOT to allow being wrong (we began shorting oil, for example at $100 – it went to $140 but THEN fell back to $45) in the short run to force a capitulation in the long-term outlook UNLESS the facts are there to support a change.
TSLA is a recent example – it simply isn't worth $90 a share and, if it goes to $180, it still won't be worth $90 and, at $270, it still won't be worth $90 but, the most important thing I did learn in 2008 is we always need to have a plan – in case things do go ridiculously against your position. This weekend we talked about more upside hedges and we have yet to add more downside hedges – even though I keep expecting a sell-off every day.
In our Income Portfolio, we have 100 DIA June $148 puts at $2 and they are down to .60 (down $14,000) and we have 30 TZA June $39 calls at $2.31, and they are down to .30 (down $6,030). That's pretty expensive insurance! Of course, the market doesn't usually go up 10% per quarter. We EXPECT to lose 50% on our insurance coverage in a quarter, not 80%! So, we're wrong – or have been so far to cover our longs – does this mean we should no longer cover our longs? GS says we have no need, right?
As I said in our weekend Market Outlook, it's very easy to outperform a bull market. In fact, the DIA July $153/157 bull call spread at $1.70 I picked as an easy market-beater is down to $1.62 and still playable this morning with the Dow drifting around flat. If the Dow gains another 400 points (2.6%) in 59 days, that little trade pays back $4 on $1.70 for a $2.30 gain (135%). That's enough to keep you ahead of inflation!
We don't need 2,100 on the S&P to make good money. The index is at 1,666 now and SPY is at $166.93 so we can grab the December 2015 (941 days) $150/170 bull call spread for $11 and that pays a whopping 81% gain ($20) if the S&P is up just 1.8% over the next 2.5 years. In fact, with a trade like this, if you are comfortable that GS won't be off by over 100% in their target, you can sell the SPY Dec 2015 $100 puts for $3.50 and drop your basis on the longs to $8.50 and boost your return on cash to 135% if the S&P is just over 1,700. It's even margin-efficient as the short $100 puts require just $10 of ordinary margin (and much less in a portfolio margin account) and that's the only trade you ever need to be as bullish as you want to for the next 2.5 years.
As a practical example, in our Virtual Income Portfolio, we have $45,600 worth of OIH that we bought for $42,460 so, a small profit. We sold 10 2015 $39 calls against it for $7.64 and we also sold 10 of the 2015 $39 puts for $4.20. OIH is currently at $45.66 so the trade is doing well and I still like them long-term but, if we want to get more long-term bullish, we can cash the stock for $45,600, buy 10 2015 $34 calls for $13 ($13,000) and that leaves us in the 2015 $34/39 bull call spread for net $5.36 less the $4.20 we collected for the puts is net $1.16 and we still make $3.84 ($3,840) if OIH is over $39 in Jan 2015 and our worst case is the stock is put back to us at net $40.16 – still less than we bought it for in the first place.
Meanwhile, we take $32,600 of cash off the table and we can use that to buy 20 of the S&P Dec 2015 $150/170 bull call spreads for $22,000 and we still have $12,600 in cash or $25,200 in ordinary margin free to offset the cost of the calls by selling some short puts in other things we find interesting like (to start) selling 10 CHK 2015 $20 puts for $3.55 ($3,550) which have a net margin of just $3,222 so very efficient as we put more cash in our pocket, use a little bit of our new margin, and knock off 16% of the cost of our long position on our first trade.
The upside on the spread is already $18,000 if the S&P simply doesn't go down from here. As we find more stocks we WANT to buy if the market turns down, we'll drop that basis to zero and our upside will be $40,000. The aim of our Income Portfolio is just to make $48,000 a year off $500,000 ($1M in margin) so that could be our only successful trade of the year and we'll be pretty happy!
So, let's not fret about "missing the rally" – there's no such thing with options! The more aggressive SPY Dec 2015 $180/200 spread is $5.60 and makes a lovely 257% far short of Goldman's 2,100 goal. As the S&P goes up, we can layer into a spread like that at $7.50(ish) – AFTER we KNOW that our original, more conservative trade is well on the way to it's own 80% profits.
That's how we can play a bull market. Don't let GS et al whip you up into an unnecessary buying frenzy. In point of fact, you can never miss a rally as they will always print more options. Speaking of which, does anyone want to buy a TSLA 2015 $135 call from me for $12. It's "only" net $147 to you…
Bernanke speaks tomorrow but I'm going to be remain concerned, technically, until the Russell proves it can hold 1,000 for two consecutive days without failing the line – that's what we'll be watching closely this week.