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December 12, 2014

S&P To Hit 2300 By Next May?

By Lance Roberts at Street Talk Live

Well, it is that time of the year again when analysts all across the country begin to roll out their predictions for the coming year. This is a pretty fruitless exercise considering that the most accurate forecasters are meteorologists, and their predictions are only good for a 3-day view into the future. However, it keeps the media busy reporting them, and you focused on all of those delicious returns you will reap in the coming year. That is if everything goes according to plan. 


S&P 2300 by May???

The latest prognostication topper was from Sam Eisenstadt who was the former research director at Valueline, Inc. His prediction is that the S&P 500 will hit 2,300 by May of 2015. That is an 11% gain over the next six months. 

Now, before you scoff at the forecast, his econometric model has a fairly decent historical track record. For example, as Mark Hulbert quoted:  
"To appreciate how good his model is, consider what its forecast was six months ago — when the S&P 500 stood at 1,924. At the time, investors were expecting a big summer correction, but Eisenstadt’s model was forecasting that the index would surpass 2,100 by the beginning of December.  As fate would have it, the market has made it 'only' to 2,074. But I don’t think any of Eisenstadt’s followers are complaining. On the contrary, in the messy world of stock market predictions, Eisenstadt’s has to be graded remarkably accurate."  
Here is what is important. This move to 2300 would very likely correspond with the 2015 "market melt-up" I discussed very early this year.  To wit: 
"There is another piece of historical statistical data that supports the idea of a market 'melt up' before the next big correction in 2016 which is the decennial cycle. The decennial pattern is certainly suggesting that we take advantage of any major correction in 2014 to do some buying ahead of 2015.  As shown in the chart above, there is a very high probability (83%) that the 5th year of the decade will be positive with an average historical return of 21.47%. The return of the positive years is also quite amazing with 10 out of the 15 positive 5th years (66%) rising 20% or more.  However, 2015 will also likely mark the peak of the cyclical bull market as economic tailwinds fade, and the reality of an excessively stretched valuation and price metrics become a major issue. As you will notice, returns in the 6th and 7th years (2016-17) become substantially worse with a potential of negative return years rising.  The chart below shows the win/loss ratio of each year of the decennial cycle."
Decennial-cycle-011414-2

But here is an important point, already stretched market valuations will become extremely stretched with such an impressive move higher. With earnings growth already decelerating, a substantial move higher in the "P" of the P/E ratio will cause multiples to accelerate sharply. The chart below shows the Shiller P/E ratio extrapolated for such a move in price.  

SP500-PE-Reversions-121114

While multiple expansions are good for "bullish investors," it is also a warning sign of a very late-stage bull market. The question is whether you need to be reminded of what happens when "multiple expansions" eventually turn into "contractions?"  

Is the Secular Bear Finally Dead?  

John Authers, via the Financial Times, asks that very important question:  
"Are we in a bull market, or are we still in a secular bear market? It is a profound question, and — at least when it is applied to stocks in the US — it also sounds like a stupid one. US stocks have more than trebled since March 2009. The S&P 500 is at an all-time high, and it has been rising, with only one interruption of any significance, for almost six years. The US labour market has now expanded for a record 50 months in succession, and the latest numbers outstripped the most optimistic projections. If this is not a bull market, what is?"  
The entire article is worth reading as he goes through various metrics in his discussion. However, I agree with his current premise that we are currently within a cyclical "bull"market still contained inside of a secular "bear" market.  

My reasoning is much more simplistic in nature.  As I discussed previously, 
"Despite much hope that the current breakout of the markets is the beginning of a new secular 'bull' market - the economic and fundamental variables suggest otherwise. Valuations and sentiment are at very elevated levels (greater than 23x trailing earnings) which is the opposite of what has been seen previously. Interest rates, inflation, wages and savings rates are all at historically low levels which are normally seen at the end of secular bull market periods."  
SP500-PE-Valuations-121114The simple reality is that secular "bull" markets are driven from periods of excessively low valuations, high dividends and extremely negative market sentiment. None of those exist currently.    
Another Year of No Capex Revival  
There has been much hope that at any given moment U.S. companies were going to release their coffers on an unprecedented spending spree. Of course, like the annual migration of Hooded Merganser, these hopes have been dashed on the rocks of economic reality. This coming year is likely to disappoint once again due to the recent collapse in oil prices.   
"US private investment spending is usually ~15% of US GDP or $2.8trn now. This investment consists of $1.6trn spent annually on equipment and software, $700bn on non-residential construction and a bit over $500bn on residential. Equipment and software is 35% technology and communications, 25-30% is industrial equipment for energy, utilities and agriculture, 15% is transportation equipment, with remaining 20-25% related to other industries or intangibles. Non-residential construction is 20% oiland gas producing structures and 30% is energy related in total.  
We estimate global investment spending is 20% of S&P EPS or 12% from US. The Energy sector is responsible for a third of S&P 500 capex. 35% of S&P EPS from investment and commodity spending, 15-20% US"
As I discussed,   
"The analysts estimate that S&P 500 companies will put around $740 billion into capital expenditures next year alone. This is roughly a 6% growth rate in Capex down from 8% in 2014. This decline in capex spending is going to disappoint market bulls who have been anxiously awaiting the revival of massive capex spending as companies ramp up to meet burgeoning consumer demand.  
The problem, however, continues to be a lack of demand follow through to justify further increases in capital expenditures. With oil prices falling due to global demand pressures, the resurgence in capex will likely be put on hold for another year as the energy sector makes up roughly one-quarter of the total S&P 500 capex and R&D spending. 
SP-500-Cash-Use
The problem for the "economic growth is coming" crowd is that corporations are indeed spending their cash, but not in ways that directly impact economic growth like capex and R&D does. 
While none of this analysis suggests that a market crash is imminent, it does imply that we are very late in the current market and economic cycle. A market melt up in 2015 would certainly be exciting, but should be used to sell overly priced assets to what will probably be a dwindling supply of "greater fools."    
Courtesy Lance Roberts at StreetTalkLive.com (EconMatters author archive here
The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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