Apparently, everyone is going to adopt on an oxymoron when describing their outlook for equities in 2018.
As noted last week, there’s something not quite right about the term “rational exuberance.” “Exuberance” implies at least a little bit of irrationality in most cases and there is most assuredly some irrationality inherent in being “exuberant” about an asset class that is stretched to historical extremes on all kinds of standard metrics.
But here’s the thing: assuming the ubiquitous “Goldilocks” narrative of decent global growth but still subdued inflation continues to be a reasonably accurate description of economic reality and assuming subdued inflation gives central banks the cover they need to keep the pace of normalization sufficiently gradual, there’s a plausible argument to be made that risk assets have further to run.
Against the backdrop, Goldman is out with their 2018 equity outlook and it includes the following S&P forecasts for the next 3 years:
Our S&P 500 year-end forecasts are 2850 (2018), 3000 (2019), and 3100 (2020) for gains of 11%, 5%, and 3%.
Their 2018 outlook hinges on three things:
The bank is calling for a 14% increase in S&P EPS next year assuming tax reform passes. If tax reform fails to pass, well then Goldman sees a 5% near-term drop in stocks.
Goldman concedes that valuations are stretched on both an absolute and a relative basis. To wit:
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.
