Do you believe in miracles? Morgan Stanley's Adam Parker does, having given up on his sane bearish case long ago, he now predicts S&P to 3,000 because "if we get EPS growth of 6% per year from 2015-2020, that would drive S&P500 earnings to near $170; a 17x multiple would translate into a peak level for the S&P500 near 3000 under this scenario." So, just some simple math, eh? But he does add, "of course, no one can predict unforeseen shocks to the economy," but they will never happen, right?
To back up this simple statement of mathematics, Parker produces 27 pages of fluff that in now way supports the actual thesis with long-term projections, simply shrugging away the fact that this would be the longest period of expansion (with no recession) in history.
Parker's Bottom line is a little less exuberant than the headline-makers would like you to believe...
Business cycles don't die of old age, they die of overheating. Debt dynamics, particularly in the US, paint the picture of a more prudent household sector and well-managed corporate sector, both of which remain far from the heights of leverage typically associated with risks to business cycle expansions. Moreover, volatility in the economy has trended lower over time, owing in part to technological advances that have helped companies remain nimble when sudden changes in aggregate demand occur, and in part to a rising share of companies that carry no inventory.
The current expansion is more than five years old, and with little evidence of global synchronicity, there are no signs as yet that the global economy is overheating. The current US expansion has already lasted longer than the average expansion in the post-WWII period, but the factors we monitor and have discussed here lead us to conclude that it isn't unreasonable to expect that this expansion could be the longest on record. In a scenario where the cycle does extend for several more years, earnings could grow modestly as well. The US Equity Strategy team notes that EPS growth of 6% per year from 2015-2020 would drive S&P500 earnings to near $170. A 17x multiple would translate into a peak level for the S&P500 near 3000 under this scenario.
Of course, no one can predict unforeseen shocks to the economy - be it fiscal or monetary policy missteps domestically, geopolitical events abroad, or even major natural disasters. But our title, “2020 Vision”, is our tongue-in-cheek way to desribe the idea that the current US expansion could prove to be the longest ever and perhaps last until 2020.
There are a number of ways the current expansion could get derailed. Europe and China are already slowing and near recession in some parts. Japan is highly dependent on the success of policy. US reforms on key issues like the budget, taxes and entitlements, and immigration seem a long way off and are likely to cause much angst in the coming years. And after a prolonged period of unprecedented monetary policy accommodation, we are on the cusp of removal of that accommodation - also in an unprecedented way. So by no means can we say that six or seven more years of expansion are an obvious outcome. But, all else being equal, the metrics we analyzed in this note are unlikely to be the root cause if this expansion were to be cut short.
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Wait, what, there are risks to this call?