Courtesy of ZeroHedge. View original post here.
Submitted by Tyler Durden.
It was just one short month ago when, on the back of the soaring dollar (which has since soared even more), as well as "diminished global GDP growth and lower crude prices", Goldman's David Kostin cut his EPS for 2015 and 2016 from $125 and $132 to $122 and $131.
Then, it was just two short weeks ago, the same David Kostin said "we expect the P/E will contract and the index will slip during the second-half of 2015 as the Fed takes its first step in the long-awaited tightening cycle. Our S&P 500 year-end 2015 target of 2100 implies a modest 5-10% P/E multiple compression to 16.0x our top-down 2016 EPS estimate or 14.6x bottom-up consensus earnings estimates."
And then, with the S&P now about 20 points away from Goldman's 2015 year end target (and just 120 points from the government-backed hedge fund's 2016 year end target!), the very same David Kostin admits that he was only kidding and that the S&P may in fact rise to a whopping 2300, using the oldest excuse in the book to admit that strategists always and forever trail price – rigged as it may be – using the Fed Model as justification for what is now effectively a 19x P/E Multiple, using Goldman's 2015 EPS target of $122 and its hint-hint revised S&P target of 2300.
To wit:
A lower interest rate scenario vs. our forecast would support a higher 2015 S&P 500 target
The drop in 10-year Treasury yields from 3% to 2.3% has been one of the biggest market surprises of 2014. We expect rates to rise next year in conjunction with an initial Fed hike and accelerating GDP growth. The persistence of low rates has led many investors to question our economists’ year-end 2015 forecast of fed funds at 0.6% and 10-year Treasuries at 3%. As the yield curve normalizes, if interest rates remain lower than we anticipate, equity returns could be greater than we forecast. Within the confines of a Fed model, an end-2015 S&P 500 level of 2300 would be consistent with 2.5% 10-year Treasuries while our forecast of 2100 assumes a 3% yield.
In other words, Goldman which was one of the biggest proponents of rising yields in 2014 and "which caught them by surprise" (leading to major losses at Goldman's own internal hedge fund) as a sign of economic stabilization, is now suggesting that yields may drop even more which would be, you guessed it, even more bullish for stocks!
So here it is:
Interest rates dominated our discussions with fund managers this week. The various interest rate scenarios articulated by clients translate into a 10 percentage point difference in the prospective 12-month price return of the S&P 500. Our interest rate projections support a 1% rise to 2100 while a lower interest rate scenario vs. our expectation would suggest an 11% gain to 2300.
Goldman Sachs Economics forecasts the Fed will start to tighten in 3Q and the funds rate will eventually climb to a neutral level of 3.9% by the end of 2018 (see Exhibit 1). At the same time, 10-year Treasury yields will rise to 3.0% by year-end 2015 and reach 4.3% in four years (see Exhibit 2).
And here comes the fun part: if Goldman is wrong, all shall be well, because the lack of rate increase simply means that the S&P will grow even more-er, and hit absolutely ridiculous levels and multiples. In fact, the only thing more bullish for stocks than economic growth, would be an absolute deflationary collapse which sends nominal yields negative (just don't ask Japan how 30 years of deflation and QE worked miracles for the Nikkei).
Right David?
David won't answer, but for a master class of how to goalseek your narrative based on which way the global wind of market liquidity is blowing, look no further than the following:
S&P 500 has returned 14% YTD. We forecast the index will continue its upward trajectory during the first half of 2015, reflecting the ongoing economic expansion and rising profit growth. We expect EPS will rise by 5% to $122 in 2015 and by 8% to $131 in 2016. However, the forward P/E multiple will likely compress from the current 17.0x to 16.0x by the end of 2015, sparked by the first Fed rate hike since 2006.
If interest rates in 2015 remain below our forecast, then equity returns may exceed our expectations. A Fed model with 10-year Treasury rates at 2.5% and no changes to both EPS and the equity risk premium would imply a level of 2300 for the S&P 500 at year-end 2015 representing an 11% gain. The P/E multiple would expand to 17.4x, higher than our baseline forecast of 16.0x. A “reach for yield” argument would support rising P/E multiples in a low interest rate environment. In that scenario, investors would be incentivized to purchase higher yielding equity assets. The 6.1% earnings yield on the S&P 500 is currently 380 bp higher than the 10-year Treasury yield of 2.3%. The yield gap has averaged 410 bp during the past 10 years and 235 bp since 1976.
All of the above, of course, means that the S&P is now poised for another 200 point vertial ramp which will take it right to 2300. What happens next? Back in May, GMO's legendary manager Jeremy Grantham provided his perspective:
What is a bubble? Seventeen years ago in 1997, when GMO was already fighting what was to become the biggest equity bubble in U.S. history, we realized that we needed to define bubbles. By mid-1997 the price earnings ratio on the S&P 500 was drawing level to the peaks of 1929 and 1965 – around 21 times earnings – and we had the difficult task of trying to persuade institutional investors that times were pretty dangerous. We wanted to prove that most bubbles had ended badly. In 1997, the data we had seemed to show that all bubbles, major bubbles anyway, had ended very badly: all 28 major bubbles we identified had eventually retreated all the way back to the original trend that had existed prior to each bubble, a very tough standard indeed.
Then, the bullish case, or in other words, what is the maximum the S&P can stretch further, before it all comes crashing down:
So now, to get to the nub, what about today? Well, statistically, Exhibit 3 reveals that we are far off the pace still on both of the two most reliable indicators of value: Tobin’s Q (price to replacement cost) and Shiller P/E (current price to the last 10 years of inflation-adjusted earnings). Both were only about a 1.4-sigma event at the end of March. (This is admittedly because the hurdle has been increased by the recent remarkable Greenspan bubbles of 2000 and a generally overpriced last 16 years.) To get to 2-sigma in our current congenitally overstimulated world would take a move in the S&P 500 to 2,250. And you can guess the next question we should look at: how likely is such a level this time? And this in turn brings me once again to take a look at the driving force behind the recent clutch of bubbles: the Greenspan Put, perhaps better described these days as the “Greenspan-Bernanke-Yellen Put,” because they have all three rowed the same boat so happily and enthusiastically for so many years.
… purist value managers may try to block out the siren call because they don’t wish to be tempted, and some may hear it and do nothing because the gains are never certain and the lack of prudence is painfully obvious in the end. Yet long-term value managers are outnumbered by momentum managers – always were and probably always will be – and momentum managers have no such qualms. Why this time, then, would they not play the game with even more enthusiasm, at least enough to drive the market to its 2-sigma level of 2,250 and perhaps a fair bit beyond? And although nothing is certain in the market, this is exactly what I believe will happen.
So far Grantham has been spot on, and now Goldman has just opened the first seal of approval that will validate the final prediction by Grantham. What happens next? Well, for the last answer we again go to Grantham from a year ago…
"the U.S. stock market is trading at levels that do not seem capable of supporting the type of returns that investors have gotten used to receiving from equities. Our additional work does nothing but confirm our prior beliefs about the current attractiveness – or rather lack of attractiveness – of the U.S. stock market…. On the old model, fair value for the S&P 500 was about 1020 and the expected return for the next seven years was -2.0% after inflation. On the new model, fair value for the S&P 500 is about 1100 and the expected return is -1.3% per year for the next seven years after inflation. Combining the current P/E of over 19 for the S&P 500 and a return on sales about 42% over the historical average, we would get an estimate that the S&P 500 is approximately 75% overvalued."
Looks like Bill Gross was right: the endgame, whatever it may be, is finally approaching.
