The reason why moments ago we showed a chart demonstrating that all of the surge in the S&P500 from the October lows can be explained with multiple expansion...
... Is that in a world in which there is no more multiple-expansion - which is merely hope of cheap and easy money - and where the S&P has to grow solely on the back of EPS growth, there would be no all time high S&P, and now relentless diagonal increase in the nominal value of stocks. This is also the basis behind the chart that "amazes" SocGen how the Fed has broken the market.
Which begs the question: will P/E multiple expansion, which at last check was just about 19x on a GAAP basis, continue, and will it hit David Tepper's mythical "20X", or are the days of growth pulled from the future over?
Well, according to Goldman's chief strategist David Kostin, who initially had forecast a 1900 price target on the S&P500 for year end 2014 only to boost it to 2050 in the summer, the days of multiple expansion are now over. As a result, Kostin suggests that the best the S&P will do in 2015, which trading at 2052 at last check is is already above his year end target, is rise a modest 5% to 2100.
Here is David Kostin's take:
We forecast US stocks will deliver a modest total return of 5% in 2015, in line with profit growth. The US economy will expand at a brisk pace. Corporations will boost sales and keep margins elevated allowing managements to both invest for growth and return cash to shareholders via buybacks and dividends. Investors will cheer these positive fundamental developments.
However, 2015 will prove to be another challenging year for active equity managers. Volatility will remain low. Stock return dispersion will stay in a narrow range making alpha generation difficult. Mutual funds and hedge funds typically lag the S&P 500 during low dispersion regimes. This year is a good example: S&P 500 realized volatility has averaged 11 YTD (37th percentile since 1962) while rolling three-month return dispersion has averaged in the second percentile versus the past 35 years. Just 14% of large-cap core mutual funds has outperformed the S&P 500. Equity long/short hedge funds have returned an average of 1% YTD, lagging the index for the sixth consecutive year.
Strategically, the multiple expansion phase of the current bull market ended in 2013. The strong S&P 500 YTD price gain of 10% roughly matches the realized year/year EPS growth of the index. The index has climbed by 17% annually during the past three years as the consensus forward P/E multiple surged by nearly 60% from 10x to 16x.
From a tactical perspective, the S&P 500 will continue its upward trajectory during the first-half of 2015. The index will climb by 5% to 2150, corresponding with a forward P/E multiple of 17x our top-down EPS forecast or 15.8x on a bottom-up basis.
However, 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.
Every recent investor discussion centers on the question of how stocks will trade when interest rates start to rise. We expect multiples will compress while volatility and stock return dispersion remain low. Our forecast of solid US GDP growth underpins our expectation of low volatility, low dispersion, and low stock returns in 2015.
We expect a benign equity market reaction to the first Fed rate hike. Fed funds have been anchored near zero for six years. The Fed has been transparent in communicating the timing and slow trajectory of its planned exit from the unconventional monetary policies it has pursued since 2008. Goldman Sachs Economics expects the first hike will occur during 3Q and short-term rates will end 2015 at 0.6% while the 10-year yield will rise to 3%.
Not everyone agrees with Kostin:
Many fund managers disagree with our view and believe higher equity volatility will accompany higher interest rates. They argue that once the Fed begins to hike uncertainty will abound regarding the pace of further tightening and volatility will jump. Our response to those arguments is that the interest rate swaption market implies a relatively steady and shallow path of future hikes with volatility remaining quiescent.
Where we disagree is two places: i) the Fed will not hike, at least not voluntarily, as the economy will continue to deteriorate and with a cold, snowy winter already in the works, look for 2015 to be a replay of 2014, when everyone predicted solid growth, only for total GDP to post another year of declines; ii) if indeed multiple expansion ends, the resultant selling will be so vicious and rapid that it will immediately result in a contraction in end demand, leading to a double whammy by making buybacks impossible, crushing EPS and forcing fabricated non-GAAP numbers to finally catch up with GAAP.
The only question is whether once the market tumbles when all this materializes, if Bullard will once again jawbone the algos to BTFATHD, or if this time, the Fed will indeed welcome higher vol as the minutes yesterday warned.
Sadly, after 6 years of constant parental supervision by the Fed of its deformed, mutant "market" baby, which as John Hussman correctly said is 100% overvalued thanks to $11 trillion in global central bank liquidity, we somehow fail to see Aunt Janet allowing stocks go to trade on their own, and in the process crushing 6 years of centrally-planned "wealth effect" efforts.