In Atlanta this week, checking in on a few existing and potential investments. But couldn’t resist following up on Night Moves with a couple additional data points.
The first comes from David Bianco compliments of Zero Hedge. This should sound familiar to those who’ve reviewed the previous targets put out by MS.
We still expect a long lasting economic expansion of moderate growth, which should rival the US record of 10 years with S&P EPS growth averaging 6% until the next recession, on 5% sales growth, flat margins, 1% share shrink. Despite entering the latter years of a typical expansion and high margins vs. history, we now think the trailing S&P PE should average 17 vs. 16 until elevated recession risk returns. This is because we now expect long-term real interest rates to stay below normal through 2016 and thus lower our S&P 500 real cost of equity estimate from 6.0% to 5.5%.
The two major threats to the S&P 500 are either a recession or a rapid increase in interest rates. However, assuming that the US avoids a recession – and no other global factor causes a significant decline in S&P EPS – and that US interest rates climb slowly and rise to a level that plateaus below historical norms, then 2500 is within reach for the S&P 500 by 2018.
So in summary – assuming nothing bad happens for the next five years – and assuming we extrapolate the same linear trend for another 4 years, the S&P 500 can rally to 2500 without any meaningful downside risk.
Why not take this logic a step further? With interest rates at zero for as far as the eye can see, isn’t a 5.5% cost of equity a bit expensive? We can justify just about any valuation for any asset if we just go ahead and use a zero percent discount rate, can’t we?
The same day we picked up this DB report, we caught this gem – Morgan Stanley’s chief international economist, Joachim Fels, appears to be fueling the bullish calls from the firm’s strategy group. Per Bloomberg, he sees recovery from the great recession potentially lasting as long as a decade thanks in part to loose money. “While the expansion is already five years old, it could easily extend another five,” Fels wrote.
Never mind that global expansions have historically lasted between four and eight years and six on average. “The glass is half full,” says Fels. It’s certainly hard to argue that the glass is half full today, but shouldn’t we at least consider the risk that investors may look at the glass differently, some time this decade?
Then again, maybe we give the street too much credit. After reading our last post, a colleague asked, “Does anyone actually believe the stuff these guys are putting out?” Experience would suggest that many unfortunately do.
Believe it or not, it certainly feels like sentiment is reaching an extreme. According to Investors Intelligence, bears have fallen to the lowest level since 1987. Last weekend’s Barron’s survey of market strategists highlighted this sentiment. Nobody thinks markets will go down. Maybe it’s time for some of us to take a page out of the average bear’s play book.
Yogi Bear: Hang on Boo Boo!
Boo Boo: What do we do now?
Yogi Bear: Did you check the safety manual?
Boo Boo: It’s just a picture of us screaming!
[Both scream and flail their arms]
Yogi Bear: We have to deject, Boo-Boo!
Boo Boo: Don’t you mean “EJECT”?
Yogi Bear: Eject is up, deject is
Yogi Bear: doooooooown!