The old saw “what goes up, must come down” apparently applies to stock markets as well as rocks thrown up in the air, at least according to Goldman Sachs Equity Research. In their US Weekly Kickstart of August 14th, David J. Kostin and team point out that US stocks have been on a roll for several years now, and markets inevitably play catch up at some point.
Kostin et al offer provide an explanation of their thesis in the introduction to the report. “We forecast the S&P 500 index will end 2015 at 2100, roughly unchanged from the current level. S&P 500 delivered a compound annual price return of 18% during the past three years and 13% during the past five years, both well above the long-term average annual return of 5%. Mean reversion is a powerful force. Put simply, “flat is the new up” when it comes to the future path of the US stock market.”
Reasons to expect US stocks to remain flat through year end
The Goldman Sachs teams offer four reasons they expect the S&P 500 to stay range bound around 2100 through the end of this year:
- The S&P 500 currently trades close to fair value based on a number of financial metrics (P/E, EV/sales, EV/EBITDA, and P/B). When real interest rates were 0%-1% in the past, however, the forward P/E multiple averaged 11.2X, a solid third less than the current P/E of 16.7X. Mpreover, the Fed Model suggests a year-end fair value of 2100 assuming the 10-year U.S. Treasury yield climbs to 2.8% and the earnings yield gap narrows/equity risk premium falls. Of note, in earlier tightening experiences, the P/E multiple has contracted by an average of 8% during the first three months after a Fed rate hike.
- S&P 500 earnings will be basically flat in 2015. Given that S&P 500 earnings are only up 1% from last year as energy earnings drop by a mind-boggling 63%. The GS analysts note that their top-down EPS and margin forecast and bottom-up consensus are very close to identical. They are estimating an average EPS of $114 and margins of 8.9% for S&P 500 firms (consensus is $112 and 9.1% margins).
- Domestic equity ETFs are seeing net outflows for the first time in a long time. U.S. domestic equity mutual funds have seen net outflows in 8 of the last 9 years to the tune of $664 billion, but the outflows have been offset by ETF inflows. Not any more. So far this year domestic ETF outflow have topped $6 billion and domestic equity mutual fund outflows totaled $90 billion, whereas international equity mutual fund and ETF inflows totaled $187 billion.
- The US economy is growing at an annual rate of 3.0%. Goldman's proprietary Current Activity Indicator (CAI), a real-time measure of GDP growth, suggests that the U.S. economy is currently growing at around a 3% annual clip. Moreover, the GS economic team projects GDP growth will average 2.6% in the second half of 2015. In addition, the labor market has improved significantly with monthly payroll gains averaging 220,000 jobs for almost three years and the unemployment rate down to 5.3%. That said, retail sales growth is slow and inflation remains well below the Fed’s 2% target. Kostin et al. note that "domestic sales represent 67% of the aggregate revenue of S&P 500 firms. Accordingly, nominal US GDP growth is the primary driver of sales growth. We forecast nominal US GDP growth of 3.3% and global ex-US growth of 3.2% in 2015."