Goldman Bets On "Rational Exuberance": Unveils Its S&P Price Targets, Sees Bull Market Lasting Until 2020

Just days after Barclays released its 2018 equity outlook with the title "Rational Exuberance"...

... Goldman's David Kostin decided that imitation is the sincerest form of flattery and in presenting his S&P price target* for 2018 (and 2019 and 2020), and has named his preview report the same:

We footnoted price target, because once again Kostin has decided to avoid making a definitive forecast for where the S&P will go in the near term, and instead - as he did one month ago - has left the trajectory of the S&P entirely contingent on the fate of tax reform over the next few months.

That said, and not surprisingly, Goldman is optimistic and sees the bull market continuing for at least another three years due to an "extended profit cycle will support a rising US equity market through 2020." As a result, Goldman sees higher profits supporting higher index levels, and its S&P 500 year-end forecasts are 2850 (2018), 3000 (2019), and 3100 (2020) for gains of 11%, 5%, and 3%."

Going back to the caveat, however, Kostin writes that "assuming tax reform passes, we forecast 2018 S&P 500 EPS will jump by 14% to $150 and the index will advance by 11% to 2850 at year-end 2018. If tax reform fails, S&P 500 will fall near-term by 5% to 2450."

Assuming tax reform does pass, and the market does not undergo the predicted 5% hiccup, Goldman's prediction is based on, you guessed it, "rational exuberance", to wit:

  • The bull market will continue in 2018: Our “rational exuberance” rests on a combination of above-trend US and global economic growth, low albeit slowly rising interest rates, and profit growth aided by corporate tax reform likely to be adopted by early next year. Assuming tax reform passes, we forecast S&P 500 adjusted EPS will jump by 14% to $150 in 2018. Equity investors will be rewarded as the index advances by 11% to 2850 at year-end 2018 and delivers a total return of 13% including the 2% dividend yield
  • Tax reform and strong economic growth drive our improved profit outlook. We raise our S&P 500 EPS estimates to $150 (2018) and $158 (2019) reflecting growth of 14% and 5%. Our forecast assumes tax reform and is above bottom-up consensus for 2018 ($146) but below for 2019 ($161) given we forecast flat (10.5%) rather than rising (10.8%) margins.
  • One final year of valuation expansion before multiples plateau. Our target implies a 3% P/E expansion to 18.2x at year-end 2018. Our valuation framework incorporates: (1) relationship between ROE and Price/Book ratio; (2) Fed Model earnings yield gap reverts to its 40-year average while Treasury yield rises to 3.0% during the next 12 months; (3) rising short- and long-term interest rates.

As noted above, Goldman raises its S&P 500 adjusted EPS estimates to $131 in 2017 (from $129) and $150 in 2018 (from $139) reflecting growth of 14%. In addition to a stronger  economic backdrop for corporate earnings, Goldman's baseline EPS estimates now include a 5% boost from corporate tax reform in 2018.

In summary, there are four drivers to Goldman's increased earnings forecast: (1) tax reform, (2) strong 2017 earnings results, (3) higher US GDP growth, and (4) higher oil prices. Excluding tax reform, we expect less margin expansion and slower EPS growth than consensus in 2018 and 2019. Our EPS estimates without tax reform are $143 (2018), $151 (2019), and $156 (2020).

What is also notable, is that Goldman anticipates tax reform - if it passes - boosting profit margins only one year: from 2018 to 2019, with the rest staying flat. Also notable: Goldman sees all profit margin growth being derived on the back of tech companies, as shown in the chart below. Ex-Info Tech margins are flat at best:

We forecast S&P 500 margins will peak in 2018 at 10.5%. Aided by the secular rise in Information Technology margins, current trailing 4-quarter S&P 500 net profit margins stand at 9.8%, a record high, and we expect full-year 2017 margins will equal 9.9%. A one-time boost from a reduced corporate tax rate and strong revenue growth for large-cap technology companies will lift 2018 margins by 56 bp to 10.5%. We expect margins will decline modestly through 2020 as late-cycle pressures continue to mount.

That said, exuberance, whether rational or otherwise, is clearly present, as Goldman makes clear:

After a nine-year rally, stocks now trade at lofty valuations relative to history on both an absolute and relative basis. S&P 500 has returned more than 350% (a 19% annualized total return) since the index bottomed in March 2009. Both the aggregate S&P 500 index and the median stock trade at extremely elevated P/E, P/B, EV/Sales, and EV/EBITDA multiples. Similarly, government bond yields on both a nominal and real basis are low (implying high valuation) and credit spreads for both investment-grade and high yield bonds are tight by historical standards.

Furthermore, any mentions of exuberance will immediately bring up the 1990s bull market, when the term first emerged courtesy of one Alan Greenspan:

On December 5, 1996, with the S&P 500 index trading at a then record high forward P/E multiple of 15x, Federal Reserve Chairman Alan Greenspan delivered a speech to the American Enterprise Institute in which he noted: “Clearly sustained low inflation implies less uncertainty about the future, and lower risk premiums imply higher prices of stocks and other earning assets. We can see that in the inverse relationship exhibited by P/E ratios and the rate of inflation in the past.” (The Age of Turbulence: Adventures in a New World, Alan Greenspan, Penguin, 2007, page 177).


Chairman Greenspan went on to pose a famous rhetorical question in the next sentence of his speech: “But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions, as they have in Japan over the past decade?” At the time, the Fed chair was concerned about what he perceived as the “looniness” of stock prices. He “worried that investors were getting carried away and stock prices were beginning to embody expectations so exorbitant that they could never be met” (p. 174).

Perhaps a more apt phrase would be one made legendary by Citi's then CEO Chuck Prince who said that "as long as the music is playing, you've got to get up and dance." One look at market and it is abundantly clear that there is a lot of dancing going on. And since nobody wants to be the first to spoil the part, Goldman will get on board, however grudgingly, as the following caveat reveals:

Unfortunately, it is only in retrospect that one can definitively establish that assets have reached unsustainable levels. Greenspan was prescient, but three years early. Following Greenspan’s speech warning of the potential for excessive valuations, the S&P 500 subsequently more than doubled (+116%) during the next three years before the Tech bubble finally peaked in March 2000 at a forward P/E multiple of 24x.

So assuming assets haven't yet reached unsustainable levels, what can one say, besides what Barclays already said last week: the rally is exuberant... but rational!? Here's Goldman:

Rational exuberance” best describes our forecast for the trajectory of the S&P 500 during the next several years. Earnings drive stocks over time and should support the index rising to 2850 at year-end 2018, 3000 at the end of 2019, and 3100 by the close of 2020, representing a price gain during the next three years of 20% (see Exhibit 1). Our price targets imply a modest expansion in forward P/E multiple to 18.2x at year-end 2018, a flat multiple in 2019, and a contraction to 18.1x in 2020.


An earnings-driven bull market is inherently rational for a fundamental equity investor. Decomposing the building blocks of a rally allows an investor to differentiate between what has a foundation of stone and what is a castle in the air. Between  1987 and 1996, the S&P 500 index was lifted by roughly 30% from P/E multiple expansion and 70% from earnings growth. The components of the current bull market that started in 2009 are similar: Valuation expansion has accounted for about 30% of the rally, profit growth about 50%, and the remaining 20% from an increase in expected EPS growth.

Meanwhile, this is what Goldman would defined as irrational exuberance:

We would deem it “irrational exuberance” if the S&P 500 during the next three years followed the exponential trajectory of stocks in the late 1990s. In that situation, the S&P 500 would trade at 5300 by year-end 2020 (a 105% rise from today). If stocks instead trade at a similar forward P/E to the Tech Bubble (24x), it would imply a year-end 2020 index level of 4050 (57% above today). During the three years post Greenspan’s speech, S&P 500 EPS rose by 26% ($40 to $50). Translated to today, such a growth rate would imply 2020 EPS of $166 compared with our estimate of $163.

To be sure, despite conceding that valuations have never been higher, Kostin tries to make an attractive valuation argument for the S&P, to which he counters that one could still see modest multiple expansion, although most of this is now in the past. As a result, the big wild card is whether tax reform passes or not, needless a rather major gamble when the delta is 400 S&P points:

Today, the S&P 500 effectively trades at a forward P/E multiple of 17.7x. The index currently trades at 18.1x forward bottom-up consensus EPS of $143. However, if the market were fully assuming corporate tax reform, then the forward EPS estimate would be $150 (assuming our estimated $7 boost from tax reform) and the index would be trading at a forward P/E multiple of 17.3x. Based on the relative performance of tax-exposed equities and prediction markets, we estimate the market assigns a roughly 50% likelihood that corporate tax reform is adopted. Using a blended EPS estimate of $146 implies the market effectively trades at a forward P/E multiple of 17.7x.

Once again, Goldman's entire 3 year forecast is contingent on just one thing: tax reform.

The largest contributor to our increased EPS estimates is corporate tax reform. Two weeks ago, the House and Senate released their respective tax reform proposals. Considerable uncertainty surrounds the final provisions of the plans, but both chambers have incorporated a tax cut of roughly $1.5 trillion over the next 10 years. Our political economist assigns an 80% likelihood that tax legislation will pass by 1Q 2018. Our baseline forecast includes several key tenets: (1) a reduction in the domestic federal statutory corporate tax rate; (2) a territorial system for foreign income, including a minimum tax rate; (3) a limit on interest deductibility; (4) immediate business equipment expensing; (5) base broadening; and (6) a one-time tax on overseas cash and earnings.

Tax reform aside, bizarrely, Goldman's argument boils down to whether the exuberance that drives the market for the next 3 years is rational or irrational. It looks something like this:

There are caveats, chief among which is that the rally will in just two weeks become the 3rd longest in history with a 5% dradown, and just 24 days later, the longest on record.

Low volatility is perhaps the most remarkable aspect of the current bull market. It has been more than 350 trading days since the S&P 500 has experienced a drawdown of 5% or more, the fourth-longest period since 1930 (see Exhibit 3). Realized volatility stands at the lowest level in 50 years. Moreover, the market term structure implies volatility will remain well-below average during the next five years. In his memoir, Greenspan notes that “one major factor causing stock prices to rise [in the 1990s] was investors’ growing confidence that stability would continue.” (page 175).

of course, there are also risks that Goldman's entire forecast will be dead wrong, and we will cover these shortly in a follow up article.


Ivan de beers thevekja Tue, 11/21/2017 - 09:44 Permalink

Market crash was set for 2015 then 2016 then 2017 and now 2018? Theres no crash coming, not in our lifetime. Maybe 2 generations from now would experience a crash. The only ones calling for a crash are the ones who hold gold and silver scrap metals, who missed out on the bitcoin bonanza and hoping for gold to go up. Wont happen.

In reply to by thevekja

khakuda Tue, 11/21/2017 - 09:36 Permalink

And this is how they get everyone in for the final muppetting.  Kostin, the bear is all of a sudden a believer in ya gotta be in it at any price.

Endgame Napoleon gatorengineer Tue, 11/21/2017 - 10:27 Permalink

If tax [deform] passes, the child-tax-credit windfall of the part-time-worker mommas with high womb productivity will only add a little, [unfair] steam to the economy.

If gas prices go up, as the GS yuppies predict, the [non working families] across many states, with per capita, earned-only income in the $19k range will drive less miles and buy fewer goods, fueling less overall growth.

There will be a brief spurt of retail and hospitality industry activity in April, as the increased number of mommas rewarded for sex & reproduction by the US Treasury Department hit the beach to spend their recently upgraded [$6,318] child-tax-credit checks for maximum womb productivity on vacations due to the extremely lenient absenteeism policies in America’s low-productivity, mom-gang workplaces.

Furniture sales will be up for a minute, as will tattoo parlor traffic and electronics purchases.

But these tax-welfare-favored mommas will not purchase BitCoin or gold and silver coins with their tax-welfare checks to hedge their freebie, womb-productivity rewards in case of an economic collapse, not even that gold coin with the finely sculpted low relief, commemorating the advent of fake feminism’s destructive second wave from the Franklin Mint.

Nor will they buy the Obama bronze coin, one of the better designs. The liberal sculptors at the Mint seem to be going all out for their PC heroes.

They even created a stunning, group-figural, low-relief sculpture on a gold coin that celebrates the civil rights movement.

Is this a good sales strategy? Maybe, goldbugs are a bunch of PC-driven liberals.

There is an equally eye-catching coin with a beautiful, pro-military composition, featuring a soldier’s head in a three-quarter’s view in the foreground and 3 combat soldiers in the background. Maybe, the conservative mommas with extra cash to invest from child tax credits will opt for that golf-bug investment.

None of the goldbug investment options with aesthetic flair and identity politics or conservative narratives will override the natural, Keynesian flow of child-tax-credit fiat currency to beach hotels, where husbands or boyfriends of part-time, low-wage momma workers will be entertained due to major bills, like rent and groceries, that are covered by welfare, spouses or ex spouses, freeing up the part-time momma workers’ “child” tax credits for frivolities [or] investment.

They’ll choose mom pampering, not the First Ladies Commemorative Coin Set in Gold, regardless of the stylish Jackie coin, or BitCoins, which most have never heard of.

The corporations will invest in stock buybacks.

And the rich individuals will try to park money in safe investments to preserve intergenerational wealth.

In reply to by gatorengineer

Two-bits Tue, 11/21/2017 - 09:43 Permalink

This is why I pick up loose change. It's always there. In this world of 3 day news cycles and short term memory being ahead of the curve is key

shizzledizzle Tue, 11/21/2017 - 09:50 Permalink

I wouldn't bet on anything rational. That being said I could totally see them holding it up until 2020 and that would be fine by me. More time to get my ducks in a row and head into the shit storm with zero debt and a healthy stack of cash to get me through the depression.

Bloody Fkn Muppet Tue, 11/21/2017 - 09:52 Permalink

In today's market helium was up, feathers were down. Paper was stationary. Fluorescent tubing was dimmed in light trading. Knives were up sharply. Cows steered into a bull market. Pencils lost a few points. Hiking equipment was trailing. Elevators rose, while escalators continued their slow decline. Weights were up in heavy trading. Light switches were off. Mining equipment hit rock bottom. Diapers remained unchanged. Shipping lines stayed at an even keel. The market for raisins dried up. Coca Cola fizzled. Caterpillar stock inched up a bit. Sun peaked at midday. Balloon prices were inflated. Scott Tissue touched a new bottom.

small axe Tue, 11/21/2017 - 10:02 Permalink

indices are tracking political and monetary repression, as always.good times for 1percenters close to the Fed godhead; the rest of us can eat dirt 

CPL Tue, 11/21/2017 - 10:01 Permalink

DOW 36000!  Bullish! Soon everyone going to be as rich as a zimbabwe trillionaire if this keeps up, the key point to this is they'll also all be as influencial as zimbabwe trillionaires as it climbs higher and higher.  Each point a dilusion into ownership and by the end of it even a man like Warren Buffet won't be able to afford a can of cat food.

khakuda Tue, 11/21/2017 - 10:04 Permalink

To try and couch this in rational analysis is a joke.  Long after the emergency, central banks are pouring gasoline all over the flames, leaving rates at emergency levels and printing money as asset prices explode higher and outperform fundamentals year in and year out.  On top, we are going to have debt financed tax cut.  If this isn't a bubble, I don't know what is.

Endgame Napoleon khakuda Tue, 11/21/2017 - 10:44 Permalink

Unlike others on here, at least, my comments are not steeped in rational, trained, economic analysis and, as such, align more with the irrational flow of the policies produced by The Swampians and their greedy constituencies, both at the top and the bottom of the economic ladder, i.e. the wealthy families AND the “working families.”

In reply to by khakuda

Amphius1 Tue, 11/21/2017 - 10:33 Permalink

These days, a PhD in criminal psychology is probably most useful in analyzing the meaning and motivation behind market players' utterances. Anyone who takes Goldman's word at face value is plain stupid.