On October 12, 2011 - wow, this was a long time ago - I penned the first of a series titled "S&P Target 1600: The P/E Decompression Stampede." We were at my favorite pivot point of S&P 1195 (SPY), technically speaking. Fundamentally, we had no clue where we were. I surmised that the news of Europe's death were greatly exaggerated, and that it would nationalize, securitize, garanteeze, sanitize, monetize and recapitalize - that series were titled "Europe Shrugged, Not Atlas" and "There Will Be No European Liquidity Crisis." As a consequence, household net worth would recover, and cause the demise of Barney Frank, Nancy Pelosi and Harry Reid. Needless to say, I felt a little lonely on the hill, and while the scenario has unfolded as planned, I have been proven wrong on Pelosi and Reid.
So, on April 6, 2013, we were testing S&P 1542. Tired of waiting, I officially upgraded my target for the S&P 500 to 2000, albeit with some short term reservations. On April 23, at S&P 1576 intraday, I threw out the reservations, with a cue from HYG (HYG). I then stopped shaving until I would be proven right. We closed at S&P 1614 on this Friday May 3, and here are the before and after pictures to prove it…
Getting from the 2009 lows to now was iffy but not that hard. We had to trust Bernanke's and Paulson's bazooka. Getting from the current high to "somewhere" which all call "uncharted territory" is "uncharted."
The Dow Model, for one, is not helpful on breakaway gaps, which is what we had last Friday, and even less on an all-time high. So we have to go back to the basic rationale behind my 2000 Target - liquidity and P/E expansion. This too is fairly simple, but still iffy - why should P/E expand, really? Why should a stock that sells at 15 times should sell at 20 times? And what happens to liquidity when QE stops?
Well, here is my take. On Liquidity, remember at this stage the Multiplier is dead. I have long said that QE will only end when the Multiplier revives. This will happen when banks have rebuilt their balance sheet, which they are currently doing. Who wouldn't when the net interest margin is in the 3% range, with financing costs at zero, and lending risk at a paranoiac level. When the Multiplier revives, the Fed will reduce its balance sheet but it won't have any impact on the larger monetary aggregates, which is what counts, and therefore not on GDP growth. So liquidity is not an issue. It may be a headline event, but not a flow of funds issue. If anything, the corollary will be that bond yields pick up with inflation expectations. By then, housing prices for one will have recovered, and household net worth will make new highs. So where will the money stay? In stocks. Let's not forget that there are $5 trillion in long term bonds out there, and another $9 trillion in short term paper.
Also, let's remember that $1 going into stocks does not raise the market cap by $1. This is what I call the "scarcity factor" for lack of a better word. I hate to refer to my book once again, but I wrote it for that purpose: to remember how those cycles occur. On page 52 (it's not mentioned in the index), I recall that at the time, we were monitoring equity inflows and outflows like an oracle would read entrails. In the week of March 11, 1999, equity inflows were $ 3.7 billion. In the week before that, there were outflows of $1.7 billion, for a net inflow of $2 billion. Yet, in these two weeks, the Stock Market capitalization went up by $300 billion. Actually, if my memory serves me right, in 1999 inflows of $300 billion translated into a $3 trillion market cap increase ... The reverse proved true, of course.
On P/Es, hey, I am not a magician. All I can say is go back to post WWII history, when Modern Portfolio Theory was invented. Check the ranges, check the differential between the Earning Yield and the 10-Year note. My call so far was that we would be back to the 14-26 range, which we are. The upside will be driven by the economy, and I see nothing stopping that train. So, for all I know, we might get to $120 in S&P Earnings within 3 or 4 years. Apply a normalized 20 times, i.e. a 5% Earnings Yield, I have no problem with S&P 2400. And if the 10-Year goes to 3% in the meantime, guess what: (([A)) the spread between the Earnings Yield will have normalized, and (([B)) money will flow out of bonds into equities.
Now, two short jumps are easier than one long one, so I'll start with my 2000 target. But there may be icing on the cake, and we are starting to get a flavor of it. Mark this one down: within two years, in time for the 2014 election, the Budget Deficit will be on a firm downtrend.
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