Goldman Sachs made big waves last week when they said the market was “overvalued”. Apparently, they were barraged by questions and concerns over this commentary and the following clarification has been making the rounds.
To be clear, they are not saying the S&P 500 will not advance in the coming years. In fact, they are clear that they think the S&P 500 will advance 20% over the next 3 years. They are simply saying that any future rally will likely be the result of profit growth and not EPS expansion.
Here’s some of the commentary:
“Last week we argued that the S&P 500 currently trades towards the higher end of a fair value range based on a variety of metrics, and noted in particular that the P/E multiple has rarely been higher than it is now, outside of the Tech bubble.
With the market close to fair value, we believe the forward path of US equities will depend on the trajectory of profits rather than further expansion of the valuation. We forecast S&P 500 EPS will grow at a 7% annualized pace through 2016, driving the S&P 500 to 2100 by the end of 2015 and 2200 by the end of 2016: a gain of 20% over the next three years.
Most client responses attempted to justify personal expectations for continued multiple expansion in 2014. This supports our observation that many on the buy-side expect price gains of 10% to 20% this year, well above the 3% upside to our target of 1900 for year-end 2014. Below we continue the conversation and respond to the most common questions.
1. Many investors asked how our conclusions would change if we used a longer historical valuation series than forward P/E, which starts in 1976. Exhibits 1 and 2 show a historical series of trailing P/E multiples since 1921 and the distribution of these multiples.
The 90-year timeseries of trailing P/E multiples shows a similar picture to the 40-year forward P/E multiple timeseries. At 18x, S&P 500 still trades above average valuation, ranking in the 75th percentile historically. While this is modestly lower than the 83rd percentile ranking of 16x forward P/E, the fact remains that market has rarely traded at a higher P/E outside of the Tech bubble, or coming out of recessions when EPS were extremely low.”
So, the market is fully valued, but that doesn’t mean it can’t go higher from here….
Source: Goldman Sachs
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.
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