The Charade – NorthmanTrader
Recently an annual ritual took place. Wall Street analysts setting year end price targets for the S&P 500 for the new year. Don’t act surprised but these latest price targets are higher for 2020. Why is it not a surprise? Because Wall Street always projects higher price targets. No matter what. And Wall Street will keep doing that until investors get led off the proverbial cliff. See Wall Street will not tell you to sell. Ever. Why? Because the entire business model is based on attracting ever more investment flows, more assets under management, more ETF allocations. The entire industry is based on fund inflows. Look closely when you see people always bullish on TV, invariably their compensation is based on assets under management or they manage ETFs or their firms are in the business of selling supply to the public, think IPOs and the like.
When your livelihood is tied to fund inflows you won’t tell people to sell. Ever.
And it’s a good gig. For one it’s pretty easy to be a bull on Wall Street. Since the technology revolution of the 1980s markets go up in most years so you have an immediate 80% chance of being right every year. And in the years you’re not, just blame the Fed or some “nobody could’ve seen it coming” event. And then project higher prices again because the Fed is bailing you out.
See this is how this game works: You issue price targets based on some notion of earnings growth and economic backdrop. Then throughout the year Wall Street ever so gently takes down earnings expectations for the very same companies they issued optimistic price targets on, and then, when companies beat these lowered expectations, it’s then marketed as earnings beats. And then you upgrade the stocks and raise price targets even higher when companies beat these lowered earnings expectations creating an ever bigger frenzy of earnings optimism. And when stocks get upgraded at the highs it entices even more investors to join the fray and hence we often end up with stocks falling apart following Wall Street upgrades. A classic example was all the stock upgrades in September/October 2018 just before the 20% market decline.
When does Wall Street issue downgrades? After the damage has already been done. Often this marks the bottom in individual stocks or even in markets. Fact is Wall Street rarely downgrades at the top. It upgrades at the top, it doesn’t tell people to sell.
The best part: Thanks to trillions of dollars of buybacks reducing share floats you don’t even need to have actual earnings growth to keep the illusion of earnings growth alive:
All you need is buybacks and an easy Fed and the charade can me maintained for years:
No, price targets based on earning targets, more often than not, are a mug’s game at best and a charade at worst, especially as far as the larger market is concerned and it poses a major danger to investors for when the cliff approaches nobody tells investors to sell, but rather to keep buying instead.
Did Wall Street tell investors to sell in 1999? No.
At the end of 1999 Wall Street issued higher price targets for the year 2000:
For reference $SPX closed at 1469 in 1999. Year end price targets for 2000 were projected between 1525-1700. The S&P 500 closed the year at 1320. The rationale for higher prices projected? Earnings of course: “First Call Corp forecasts a 17.2 percent average earnings gain for companies in the S&P 500 next year”. Of course that didn’t happen as markets peaked in March of 2000 and then proceeded on a 2.5 year run to ever lower prices before bottoming at 786 in October 2002. Did Wall Street forecast 786 on $SPX? Of course not. Nobody did. Not even close.
We saw the same cycle repeated leading up the financial crisis. The recession officially started in December 2007. Did Wall Street tell investors to sell? Of course not, higher price targets were again issued:
$SPX closed 2007 at 1478 and price targets in the 1600-1750 range were issued for 2008. $SPX closed 2008 at 903 before bottoming at 666 in 2009. Any price targets from Wall Street for $SPX below 1,000? Of course not. Not even close.
But we don’t have to go that far back to see the same behavior again repeated.
At the end of 2017 Wall Street enticed investors with $SPX 3,000 targets for 2018 as $SPX closed 2017 at 2673:
At the end of 2018 $SPX closed at 2506. Slight miss.
But don’t blame us, it was the Fed policy error. How dare they raise rates and reduce liquidity. As it turned out earnings forecasts used to justify price targets ended up having nothing to do with the market’s behavior. Earnings growth was strong in 2018 thanks to the tax cuts.
Even 2019 reveals an important element of the charade: The basis for the projections are often not only wrong, but also totally irrelevant.
Wall Street once again called for a higher prices in 2019 and this time correctly so, but not because of the justification for the price forecasts. Indeed these justifications were all wrong. Earnings forecasts were to be $178 per share for 2019 as $SPX targets were once again set to 3,000-3,100. But earnings didn’t come in anywhere near $178. They came in at $163. The best part: Despite that sizable miss in earnings growth projections $SPX exceeded price targets by closing 2019 at 3230.
How cool is that? You can be totally off on your earnings forecasts and still see your price targets exceeded.
We all know why of course. The Fed’s massive liquidity injections in addition to the policy flip flop and three rate cuts catapulted markets higher on multiple expansion pure:
And hence all market gains above the 2018 highs have come on the actions of the Fed, not on earnings or growth. See, it’s only a Fed policy error when stocks go down, nobody calls a massive Fed driven asset price inflation rally a Fed policy mistake.
And so now for 2020 we once again see higher price targets issued:
But there’s a problem. Because price targets have to be once again higher a justification needs to be shown. As usual that justification is to project earnings growth for next year.
The earnings forecast basis for the targets? $178. But note that’s the same earnings target that was given for 2019 to justify price targets of 3,000-3,100. Now the same earnings forecast is used to justify price targets of 3,425-3,600 or even higher. The implication: All is based on continued multiple expansion, not fundamentals otherwise you wouldn’t come up with a price target 400-600 $SPX handles higher using the same earnings forecast.
If there was consistency to the forecast price targets should be back at 3000 – 3100 for this type of earnings forecast. But of course nobody wants to show declining $SPX price targets and hence investors are led to buy into an ever pricier market that stretches to historic market cap versus GDP valuations:
This is how one leads investors off of a cliff. Keep buying the multiple expansion. Stocks are cheap. Except they’re not.
Via Robert Shiller the inventor of the CAPE ratio:
“C.A.P.E. reached 33 in January 2018 and is almost as high now, at 31. That number might seem meaningless in itself, but it is significant when you consider that it has been as high or higher on only two occasions: 1929, just before the 85 percent stock market crash ending in 1932, and in 1999, just before the 50 percent drop at the beginning of the new millennium”.
But the economy will be better investors are being told. Green shoots. Don’t you know. Who’s telling you that?
The same economists that told you the 10 year was going to 2.5%-3% in 2019?
— Sven Henrich (@NorthmanTrader) June 10, 2019
The 10 year famously dropped to near 1.4% before closing the year at below 1.9%. Not even close.
Hence I make the point: Nobody knows anything 12 months out. Not Wall Street, not economists and most of all not the Fed.
In December 2018 the Fed was still insisting on rate hikes and balance sheet reduction for 2019. Instead they cut rates 3 times and have ballooned their balance sheet by over $410B since September.
None of their projections have panned out, they didn’t see the need for repo coming and they’ve not once reached their dot plot targets nor their inflation target. And now they’re telling they’re on hold. Please. The Fed is chasing reality and is reactive, they have zero insight into anything. Worse, they’re entirely dishonest in their communications.
I present you as evidence their explanation for equity price increases in Q4. From the most recent Fed minutes:
“Broad stock price indexes increased moderately over the inter-meeting period amid movements largely attributed to trade-related developments and stronger-than- expected U.S. employment reports”.
The Fed continues to refuse to acknowledge their role in driving equity prices. Since I can’t fathom them being that ignorant I have to consider this to be willful deception.
So you have a Fed that is chasing their own policy, doesn’t see slowdowns coming and is using the equity market to bring about a turn in economic growth without ever admitting to do so.
Via David Rosenberg, leading economic indicators without the S&P 500:
Where is the evidence that the economy is bound for a miraculous recovery? Not according to the latest data released just yesterday:
Ladies and gentlemen I present:
The greatest economy ever.
Rising prices, slowing orders, manufacturing and employment.
Now let’s pay 153% market cap to GDP for stocks because of the Fed. https://t.co/n94iFckgLB
— Sven Henrich (@NorthmanTrader) January 3, 2020
And the Fed? Here’s the New York Fed yesterday:
Weekly GDP Nowcast: https://t.co/hSGXo6rV8j
Q4 2019 → 1.1%
Q1 2020 → 1.0%
— New York Fed (@NewYorkFed) January 3, 2020
The New York Fed is telling you 1.1% GDP growth while the Atlanta Fed insists on 2.3%. They’re all over the map.
So let me summarize: Wall Street got the economic projections wrong, got the yield projections wrong, got the earnings projections wrong and the Fed got everything wrong and everybody is celebrating system failure.
And now let’s use artificial liquidity driven market prices as evidence of more good things to come at a time when valuations are stretching historic boundaries. Wall Street is again telling you to buy and maybe the liquidity equation will succeed to keep the party like it’s 1999 atmosphere going. But if 2020 instead proves to be a historic selling opportunity know that Wall Street will not have told you to sell.
The charade shall be maintained and the cycle repeated.
It is not until a bubble bursts that the lessons are learned only to be forgotten again. Below are some notable quotes in the aftermath of the infamous 2000 tech bubble again relevant now that markets have risen for 10 years in a row and everybody is projecting nothing but blue skies again:
Dec 29, 2000: “We became very complacent that technology was going to go up for ever,” said John Hughes, stock strategist at Shields & Co.
October 14, 2001: “Wall Street analysts can’t resist setting price targets for the stocks they follow, even though the practice seems to have limited value for predicting where a stock is headed”.
Price targets are “purely marketing” on the part of analysts, said Marshall Front of money management firm Front Barnett Associates. “Analysts are part of brokerage firms, and their motivation is to cause their investors to move money from one stock to another,” he said.
Investors may want to heed these voices of the past or risk relearning the same lessons. Nobody knows the future 12 months out. Not Wall Street, not the Fed, not economists. To claim so is a charade.
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