As discussed earlier, Goldman's entire S&P500 price forecast for 2018 and the next three years is based on two things: tax reform passing, but more broadly, something that David Kostin dubbed "Rational Exuberance", to wit:
“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%. 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.
As Kostin describes it, "rational exuberance" is defined by "above-trend US and global economic growth, low inflation, low albeit slowly rising interest rates, and underlying corporate profits boosted by pending corporate tax reform likely to be adopted by early next year."
So far so good, but as Kostin also explained, absent tax reform passing, the S&P will not only not hit 3,100 in 3 years, it may well be lower: "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." Meanwhile, "If tax reform fails, S&P 500 will fall near-term by 5% to 2450."
It was not clear what would happen to Goldman's 2020 S&P price target of 3,100 if tax reform does not pass.
What was clear is what would - according to Goldman - happen if the rational exuberance is, in fact, irrational. Here the bank notes that it is impossible to know ex post what flavor the current exuberance has: "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 what would happen if the exuberance that awaits the S&P is, in fact, irrational? To that question, Goldman has a ready answer: "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 such a case, Goldman predicts that the S&P 500 would trade at 5300 by year-end 2020 (a 105% rise from today). If slightly "less irrational" bubble over the next three years would mean stocks instead trade at a similar forward P/E to the Tech Bubble (24x), and 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, Goldman calculates such a growth rate would imply 2020 EPS of $166 compared with our estimate of $163.
And for the visual traders, the light blue line in the chart below - i.e., the "irrational" one - would recreate the late 1990s exuberance in the context of today's market.