Is there such a thing as too much good news? According to Goldman Sachs, the answer is yes.
Over the weekend, we reported that per the latest Weekly Kickstart report from Goldman's chief equity strategist, David Kostin, there was only one question on Goldman clients' minds: when will the current rally, which is about to become the longest in history without a 3% correction, and 333 days without a 5% "drawdown", finally end?
As usual, Goldman provided a variety of arguments why the rally could continue (passage of tax reform the key upside catalyst), and why it could end, mostly because stocks have never been more overvalued...
... although Kostin warned that usually attempts to time a market correction end in tears:
Catalysts for equity market corrections are notoriously difficult to identify ex-ante. In fact, catalysts can even be difficult to identify in retrospect; historians still debate the cause of the Black Monday plunge although portfolio insurance is viewed as the reason the collapse was so dramatic. We do not expect an imminent drawdown, but the risks identified most frequently by clients may limit medium-term S&P 500 upside.
Still, there is one economic indicator that, according to Kostin, has emerged as a red flag of caution. According to Goldman, the most actionable economic indicator currently is the manufacturing ISM, which has so far provided the green light for stocks to maintain their ascent (even as "hard" economic data has been anything but stellar in recent weeks):
Economic growth is the most important driver of corporate earnings and equity performance. Since the Tech Bubble, S&P 500 returns have generally tracked the pace of US economic activity as captured by the ISM Manufacturing Index. After dipping in 2Q, the index has surged in recent months and in September hit 60.8, the strongest reading in 13 years (since May 2004). The US acceleration matched a surge in global growth; our global Current Activity Indicator shows a 4.9% pace of real economic growth, nearly the fastest in five years.
So far so good. The concern, however, is what happens next, and it is here that "too much good news may be bad news." According to Kostin, "although economic data are extremely strong now, an ISM reading above 60 typically marks the peak of growth and presages economic and equity deceleration. Since 1980, the ISM has exceeded 60 in eight separate episodes; four of those lasted only one month."
And the punchline: "Investors buying the S&P 500 at ISM readings of 60 or higher have gone on to suffer negative three- and six-month returns on average as economic activity slowed."
In other words, "an environment of synchronized global growth acceleration today raises the risk of coordinated global slowdown tomorrow." And that's not even including "coordinated global" tapering by central banks, which sooner or later will be priced in by the market.
Furthermore, since much of the "global, coordinated economic growth" was largely a byproduct of China's tremendous credit impulse in the months headed into the 19th Party Congress, which is ending shortly, and as a result China's credit injection is about to slow significantly if not shut outright, the likelihood of a sharp drop in US and global manufacturing surveys is rising rapidly.
Finally, keep in mind that despite its caveat of a 2nd year-end S&P price target of 2,650 if tax reform passes, Goldman's official target for the US market remains 2,400, or nearly 200 points lower. So will market repricing be driven by a slowdown in manufacturing, especially once the full knock-on effects from the recent hurricanes is fully priced in? And will a bearish Goldman prediction finally come true? The answer will be revealed over the next few weeks when the next round of Flash PMIs and ISMs are revealed.