The S&P 500 (INDEXSP:.INX) has only just crossed over 2000 and Morgan Stanley analysts Adam Parker and Ellen Zentner are already looking to the next major milestone, arguing that this economic expansion still has enough gas to get us there.
“An S&P 500 peak of near 3000 is possible should the US expansion prove to have five or more years left to it, based on 6% per annum EPS growth through that time frame and a 17x price-to-earnings ratio,” write Parker and Zentner in a September report.
S&P 500 – Economy only now starting to expand: Morgan Stanley
Even though the current expansion is slightly older than the post-WWII average of 58 months it’s still well below the longest expansion (March 1991 to March 2001), and Parker and Zentner argue that it’s really not a question of age but of overheating anyhow. The disappointing pace of the recovery that has so many people worried could mean that we’re in for a long, gradual recovery like we saw in the 1990s instead of the fairly rapid expansion and burst last time around.
Instead of just focusing on whether the economy is currently expanding or contracting, Morgan Stanley recently introduced its US Cycle indicator, measuring the deviation from historical norms for macro factors including employment, credit conditions, corporate behavior, and the yield curve, and then dividing the economic cycle into four different parts: downturn, repair, recovery, and expansion. By this measure, the US has only recently entered the expansion phase of the economy and still has a good way to go (though how much of the eventual expansion is already priced into the market is another question).
Even without knowing exactly how the cycle indicator is put together, we can see how some of the indicators it’s meant to represent paint the same picture. Consumer confidence, for example, passed 80 back in March of this year (a level that Parker and Zentner associate with the recovery phase) and hit 92.4 last month, approaching the 100-level that they associate with expansion.
High yield spreads also seem to be following the 1990s expansion more closely than the last expansion, although considering the level of monetary intervention going on it’s hard to know how comparable the situations really are.
Debt dynamics point to easy payments for at least a few more years
Another factor that Parker and Zentner think could keep the expansion going is that even though absolute debt levels are high, payments are low and the risk of mass defaults in the near future seem low. Households have deleveraged somewhat since 2008, but we’re still well above the absolute figures from ten years ago.
But the ratio of payments to after-tax income has plummeted to the lowest level in nearly thirty years. That bodes well for households’ ability to keep up with their payments, even if it’s going to be a long time before that debt is paid off.
Similarly, Parker and Zentner point out that high levels of corporate debt shouldn’t create problems in the next few years because companies have taken advantage of low rates to push out the maturity of that debt and increase interest coverage from 4x to 8x since the end of the crisis.
“The current US expansion has already lasted longer than the average expansion in the post-WWII period, but the factors we monitor and have discussed here lead us to conclude that it isn’t unreasonable to expect that this expansion could be the longest on record,” they write.