Displaying items by tag: valuations
There has been a lot of speculation over the last month about whether the market is in a bubble. The reason for this are numerous: the huge run up in large cap growth stocks, the meme stock frenzy and beyond. However, the answer to whether the market is in a bubble can be found in a recent study and paper by Harvard. Researchers from the university outlined what bubbles really are, and clearly show that by historical standards there is only one sector of the market currently in a bubble: the S&P 500 Technology Hardware, Storage & Peripherals index, which does include Apple. However, no other sectors, nor the S&P 500 itself could be considered to be in a bubble. In fact, it is quite rare for the market as a whole to be in a bubble. Rather, market bubbles are usually constrained to a small handful of sectors. This could be seen in what is considered to be one of the biggest of all time—the Dotcom bubble. In the late 1990s and early 2000s, tech stocks surged to extraordinary valuations, while many sectors, like value stocks, lagged. When the bubble burst, many sectors actually benefitted (like value stocks).
FINSUM: This history is quite useful for context, but as our readers know, we feel each market cycle is unique and thus historical insight can only take you so far. In this instance, we think it is important to take into consideration that bonds are yielding very little, meaning there is no good alternative to equities. We believe this situation—which is obviously created/supported by the Fed and government—will help continue to lift equities.
The annual next-year forecast cycle for Wall Street’s investment banks is in and some of the findings are interesting. As usual, banks are fairly bullish. However, that was certainly not automatic this year given the huge tumult in markets in 2020. One particular forecast stood out—Goldman Sachs. The bank’s research team, led by David Kostin, has its official 2021 S&P 500 price target as 4,200, or just about 14% ahead of today. Interestingly, the bank also thinks gold is going to rise strongly, from the mid 1,800s today to 2,300. According to Kostin, “On absolute metrics like price/earnings...the market is very expensive relative to its history, in the 90th percentile or greater … But relative to interest rates, the stock market is somewhat attractively valued. Those are two different stories—absolute valuation versus relative valuation”.
FINSUM: As tough as it is to swallow on a historical basis, we think the interest-rates measured basis for current valuations makes a great deal of sense.
One of the big annual market traditions has begun: banks and their analysts put of their year-ahead forecasts. This year has seen a wide range of forecasts, but one thing is becoming apparent—analysts are bullish, and more so than usual. Jefferies has the most aggressive forecast, saying the S&P 500 will close 2021 at 4,250; it is at 3,662 now. Analysts are bullish because of the coming vaccine and central banks which will continue to be accommodative. However, Barclays adds a third consideration—that the economy is doing much better than anyone thought it would be at this point. According to Barclays “with central banks set to remain accommodative for several years, a likely drop in global trade tensions, and unappetizing fixed income returns, we remain overweight risk assets over core bonds”.
FINSUM: Yes valuations are high, but given the overall economic position the US is in (including the vaccine), it is hard not to be optimistic.
It seems to all be crashing down as we write. The markets had just eliminated all losses for the year and were above or near all-time highs (e.g. the Nasdaq). However, the market has all he hallmarks of irrational exuberance—indexes priced for such unlikely perfect outcomes that they just can’t stand. At 22x forward earnings, valuations are right around where they were in the tech bubble. The economy is likely to take two years to recover from the virus, but the markets only took two months.
FINSUM: The market seems to be getting a reality check this week. Legitimate fears of a second wave are growing as re-opening states are seeing hospitalizations surge.
In a recommendation that speaks volumes to clients about the bank’s position on the markets, Citi put out a note to corporate clients this week which instructs them to tap markets for as much funding as they can get right now because the market is totally unrealistic. According to the co-head of investment banking at Citi, “We definitely feel that the markets are way ahead of reality. We really are telling every client to tap the market if they can because we think the pricing now couldn’t get any better”. He continued, “Markets are pricing a V [shaped recovery], everyone’s coming back to work, and this is going to be fine … I don’t think it’s going to be that easy quite frankly”.
FINSUM:A V-shaped recovery is highly unlikely at this point. We think the Nasdaq being where it is isn’t illogical because of how many of its constituents benefit from COVID. But for everyone else, this level of optimism seems disconnected from reality.