Goldman's Clients Have Just One Question: Is It Really 1987 All Over Again?

Until last Friday, there was one ominous comparison being thrown around for the stock market: the burst in the S&P for the month of January was the best start to a year going back all the way to the infamous 1987, when the year ended sharply lower despite its own January euphoria.

Now, one week later, there are other, more troubling comparisons to 1987, and specifically that year's "Black Monday" crash. First, from a purely economic perspective, David Rosenberg summarized it best last week noting the sharply "rising bond yields. Full employment.  Fed tightening. Trade frictions. Weak dollar. Rising twin deficits, spurred by tax reform. Sound familiar? It should. This was 1987."

Then, last week's widely telegraphed market drop finally happened, one which sent the Dow Jones lower by 1,000 point in the span of 5 days and which with its demonic 666 point plunge on Friday, was also the 6th biggest daily point drop in Dow Jones history.

All of the above appears to have spooked Goldman's clients who - as David Kostin writes in his latest weekly Weekly Kickstart - have one nagging question: is this 1987 all over again.

Despite market volatility this week, the S&P 500 has risen by 3% YTD. The 3.9% decline from last Friday’s close eclipses the 2.8% max drawdown of 2017. Nonetheless, 2018 ranks as just one of 13 years since 1950 to start with a January return greater than 5%. The volatile start of 2018 surprised many investors and caused clients to ask if they should [A] raise their return expectations for the full year, or [B] expect a sharp correction. In particular, investors ask about the likelihood of a repeat of 1987, when a 13% January return and additional 20% rise through August were destroyed on Black Monday, Oct. 19, when the index fell by 20%. The full-year return was 2%

Here Goldman is put in the awkward position of having to defend its year-end price target of 2850, which was briefly eclipsed in the past week, as the S&P was melting up in an unprecedented "blow off top" eruption. So on one hand, Goldman's chief strategist has to explain why he is still bullish, and on the other, why there is virtually no upside left yet why Goldman's clients shouldn't sell their holdings and pack it in for the year. This is how he does it.

In November we described our outlook for 2018 as one of “rational exuberance.”  Our expectation was that EPS growth of 14% would lift S&P 500 to 2850 by year-end, but that valuations would remain flat in contrast to the bull market that ended in 2000. With S&P 500 sitting just 3% below our year-end target, significant further appreciation will require either an upward revision to our EPS growth forecast or belief that “irrational exuberance” will lift multiples. The latter scenario would increase the likelihood of a subsequent correction, in our view. Of course, as our colleagues recently noted, a third possibility is that the market suffers a near-term correction before the bull market resumes.

Ok, so, upside is capped because the alternative is a full-blown bubble meltup which will result in a crash. On the other hand, Goldman wants you - its client - to know that a more methodical grind higher should not provoke flashbacks to 1987, preventing it from becoming a sell-fulfilling prophecy as everyone dumps at the same time, something we saw on Friday.

This is how Goldman makes the case that what we saw is not 1987.

Unlike in 1987, the equity market’s YTD rise has been driven primarily by accelerating earnings growth. Record revision sentiment has lifted the consensus bottom-up 2018 EPS estimate by 7% since November. It now stands at $156, representing 18% growth vs. 2017. The bulk of the optimism reflects the incorporation of tax reform into analyst estimates. EPS growth and revisions have contributed all of the S&P 500 YTD return, whereas P/E expansion drove the entire index rise in January 1987.

Goldman then really doubles down, and desperately hopes to reassure you, its skittish client, that not only were there notable differences between 1987 and now, but that other years had just a strong start as 2018 and did not end in a fiery inferno.

By focusing on 1987, investors overlook other historical episodes that suggest a much better outlook for US equities in 2018. Of the 12 other years since 1950 that started with a January return greater than 5%, 1987 is the only one in which the February-December return was negative. Across all episodes, the median 11-month return was 17%

At the risk of pointing out that Goldman is protesting just a little too much, it is perhaps worth asking why are Goldman's clients so eager to compare the current environment to 1987: is it because of all those economic similarities listed by David Rosenberg last week, or because the "muppets" dumb as they may be, realize that without the Fed backstopping this whole charade, the crash that is coming will make 1987 seems like a dress rehearsal.

Ironically, in the very next paragraph Goldman admits that left on their own devices, a crash is inevitable, here's why:

A further market rise is unlikely to stem from valuation expansion. The median S&P 500 firm currently trades in the 99th percentile of historical valuation on a variety of metrics. Although near-record valuations suggest disappointing long-term returns, multiples are typically poor predictors of short-term performance. Nonetheless,  rising short-term and long-term interest rates should limit further P/E multiple expansion. At 2.8%, the US 10-year Treasury yield has risen by 40 bp in the last two months and now stands at the highest level since 2014. We expect it will reach 3.0% by year- end as the term premium rises and the market moves toward our economists’ forecast of four Fed rates hikes in each of 2018 and 2019.

But the biggest risk to a coordinated liquidation is neither fundamentals, nor vivid recollections of Black Monday (by those traders who were at least alive when it happened), but investor positioning. As of this moment, institutions and hedge funds have never - ever - been more bullish:

CFTC equity futures positioning data show that investors increased long US equity positions by $40 billion this year, bringing long and net positions to new record highs(see Exhibit 4).  Similarly, NYSE net margin debt is at its highest level relative to market cap since at least 1980. 

And after a week like the last, if what was until recently going only up no longer goes up, there is just one alternative: down, express elevator style. It will be amusing to watch as the record net long exposure turns not so net long, especially with traders having forgotten how to sell thanks to sentiment at the highest on record.

Which brings us to Goldman's tacit hint what happens next: "Investors who are already long cash equities could instead consider purchasing puts as protection", which 'curiously' is precisely what Morgan Stanley said two weeks ago.


NYSE, October 19, 1987.

Comments

Son of Captain Nemo Sat, 02/03/2018 - 17:56 Permalink

Goldman's clients Have another question... Is it really 2018?...

And WHY AM I NOT "DEAD" YET FOR ALL THE EVIL SHIT, GREED AND STUPIDITY THAT GOT ME TO THIS "PLACE"?!!!

Goldman's answer: YOU WISH THIS WAS "1987" SO "DREAM" LIKE IT IS!...

BECAUSE WHAT HAPPENS NEXT IS GOING TO MAKE YOU REPEAT THE WORDS "GEE!... THOSE WERE REALLY GREAT MARKET CRASHES I WANT TO RELIVE OVER... AND OVER...!!!

The Real Tony JesseL Sun, 02/04/2018 - 10:35 Permalink

I take credit for causing the '87 crash and take credit for Hillary losing the election. I bought DOW Chemical AT 10:20am the day of the crash. I was "all-in" on HVI.TO about 10 days before the November election. Sold the position at the open election day after being down a King's ransom at 2:00am. I'll be asking friends this time if they want to fork over money for me to buy a stock this Monday. So far anyone long the market is safe as of now.

In reply to by JesseL

EternalAnusocracy kbohip Sat, 02/03/2018 - 18:41 Permalink

The trend has clearly changed.  Bond yields are rising fast.  Equities will not fare well in this environment.  Bond funds are taking heavy losses also.  Next week is going to be critical.  PPT is working overtime this weekend.  If the slide continues, then the capitulation in a couple of weeks (once we are down 12-14% from the highs) will be devastating.  May take four years before we see new highs in the S&P 500.

I will go out on the limb and say that the high for this market was back around Jan 30.

In reply to by kbohip

MK13 EternalAnusocracy Sat, 02/03/2018 - 19:21 Permalink

GS is probably correct, correction to curb the leverage. Crash? Haa, haa, haa. Not unless it's driven by someone.

There has never been a crash within 30 days of new SP500 high. Never. Black Monday was even primed back and forth for awhile.

Reversals also happen within few days of monthly options, so around February 15th will be going higher. And probably by Monday afternoon after shaking out a few hands in morn.

In reply to by EternalAnusocracy

Harry Lightning kbohip Sat, 02/03/2018 - 18:46 Permalink

Feel lucky they are giving you a warning, and take advantage of it.

The market fell 1000 points in one week. That doesn't happen without a huge change in the prevailing sentiment of the people who control the capital that gets invested. Some major factor in the pricing equation has changed, it may not become apparent for months to come. Whatever it is does not matter, what matters is that the people who control vast sums of capital thin it matters and are acting accordingly. 

Perhaps is simply profit taking after a nearly thousand point a month rise since Trump's election. Perhaps its the ten year note breaking through a major resistance line, signaling that the era of low inflation and low interest rates is over. Perhaps someone knows something about the investigation into Trump. If you are going to wait to find out what the reason(s) is while holding a long position, you are setting yourself up for a big loss. Take your money off the table and wait. That is the play of the day.

Frankly, there are two reasons for the market's incredible run since Trump's election, and those reasons already are priced into the market. If you analyze the underlying fundamentals of the market's reaction to those reasons, you soon start to wonder why the market even got to the heights it did.

The first reason was sold as a massive tax cut for US companies. That was not really the case, because most companies were not paying anywhere near the corporate tax rate after accounting for loopholes and deductions. For the most part, nearly all companies will be paying the same taxes going forward as they have in the past as a result of this tax bill.

The real income producer was on the deal to repatriate the earnings held overseas. The thinking was that companies would invest trillions of dollars of repatriated funds, and that would help the stock market. The mistake made was to assume the earnings held offshore were not already invested. As if the only way a company can invest its earnings is if it brings them on to the US shores. This was propaganda used by the supporters of this largest of corporate welfare in US history to gain votes and popular support for this giveaway. Who doesn't want to see the stock market go up ? 

The problem is it was a big lie. Those earnings already were invested in securities to the extent that the companies wanted to invest the funds. The only thing the tax bill does is allow the companies to transfer those holdings into the name of an onshore rather than offshore unit of the company. There is no net effect on the stock market from the repatriation of these funds. Hence, the stock market should not have risen based on this lie.

Second reason was deregulation in a Trump administration lowering the cost of doing business, and therefore leading to greater profits. This may very well occur, but the increase in profits should not increase the already overbought Price To Earnings and Price To Sales ratios of the stocks traded in the stock market. In fact, based on the historical outcome to the economy every time deregulation has occurred on a grand scale, stock multiples should be contracting rather than expanding. 

So the bottom line is that the 9000 points the Dow added since the election of Trump is way overdone. How much overdone remains to be seen. So far about 1000 points have been returned. Perhaps another several thousand need to be shed, until Price multiples retreat a safe distance from historically feverish levels.

And that's if all else remains the same, and if the only reason for the price retrenchment is to more accurately reflect the effects of the Trump policies. I think that you need to give a lot more credence to what the bond market is telling you by breaking through the long term resistance line in the 10 Year Yield. Because if indeed the market has concluded that higher levels of inflation are here to stay for the foreseeable future, then the entire stock market pricing equation must change in a serious way. That's another story for another time.

For now, you should be very careful about what the market is telling you. This could very well be the beginning of the end, when the entire debt-fueled house of cards that has propelled stock prices globally to these record highs finally and mercilessly falls to the ground. I would recommend you study the price action of the Nikkei 225 Index starting in December of 1989 and continuing through 1990. Because the Dow very easily could suffer an identical fate, all of the factors that caused the devastation in Japan are eerily similar to what afflicts the US markets today.

 

In reply to by kbohip

MK13 Harry Lightning Sat, 02/03/2018 - 19:28 Permalink

A 2.5% correction does not a bear market make, not when market was up 7-8% YTD. It's taking out the fluff. If Jan is positive 96% the year will be, if you are shorting/putting, you're paying the brokerages/banks.

If you study charts, bear market gets primed, at least a month out from new high, usually 2-6 months. And it has reversals few can follow. Good luck.

In reply to by Harry Lightning

zzzz88 Sat, 02/03/2018 - 21:47 Permalink

i just share some info with you guys---

in the last 25 bear markets, 5 times the peak is in November; 1 in december; 3 in jan; 3 in feb; 2 in march.

or 48% of the peaks are in Nov-Feb--4 months. 

 

Akdov Telmig Sun, 02/04/2018 - 00:07 Permalink

Apple has made 20B of profits in the 2017 4Q as an exemple, an absolute record and people are still wondering why the stock market is at an all time high?

It's because of the earnings growth we had year over year, and the trend isn't going away for the US stocks any time soon with the USD devaluating against peers alone, that makes the US corporate companies moare competitive globally, BTFD is still the name of the game at least for me.

jt_54321 Akdov Telmig Sun, 02/04/2018 - 02:58 Permalink

It is true that US is home to a few giant corporations like Apple, with a lot of customer friendly innovative products , and thus competitive advantage...

But in general, when it comes to market valuations, it is being totally manipulated by central banks by printing-to-infinity and artificially maintaining a low inflation rate....

Let them bring the QE back to normal levels and stop manipulating inflation rates. Then one will get the true price mechanism into the system  and then only one will know the true stock price ,,, which is likely to be a lot lower...

In reply to by Akdov Telmig

The Real Tony Sun, 02/04/2018 - 10:40 Permalink

The bankers can either sell everything to all the suckers who are still in the market or the bankers can buy up everything and no one makes a red cent ever (including the bankers) as all the bankers can do is trade stocks with all the other bankers. The longer the bankers perpetrate this all-out fraud the more likely all of them will be criminally prosecuted.