Goldman Sachs hit the ground running this year by putting a 2021 price target on the S&P 500 of 4300 and 4600 by the end of 2022. If we use their “current level” of 3551, such would be a gain of 21.1% for 2021 and roughly 7% for 2022.

To support that growth in stock prices, you need strong earnings growth to keep expensive valuations at some “less crazy” level. To accomplish this feat, Goldman stretched reality to $175 in EPS for 2021 and $195 in 2022.

How good was Goldman’s estimate for 2020?

Goldman used $136 in Operating (Earnings Before Reality) for 2020, which is currently $16 per share higher than S&P is presently reporting.  That’s a BIG miss!

 Assuming that Goldman Sachs is correct, this would put valuations on the S&P 500 of 24.57x operating earnings in 2021 and 23.59x in 2022. Such levels remain extremely expensive by any historical measure.

The problem is that no one in the financial media, Wall Street, or anywhere else holds analysts accountable for their calls. Take a look at the table below using data from S&P Global:

 

 

Analysts consistently overestimate earnings by as much as 30%.

While analysts are rushing to set the highest target price possible and overestimating earnings to “justify” them, the next 12-months will see those targets sharply reduced.

The divergence between the stock market and the economy is unsustainable.  See chart below:

 

 

Since 2009, the operating earnings per share of corporations has risen by 276%. However, the increase in earnings did not come from an increase in revenue. During the period, sales (which is boosted due share reductions) grew by a marginal 43%.

However, investors have bid up the market more than 400% from the financial crisis lows of 666.

 

 

During that period, almost 100% of the net purchases of equities came from corporations.

 

 

In 2021, earnings are likely to come in once again substantially lower than Goldman’s high estimates. But such shouldn’t be a surprise since they are never accurate historically. More importantly, if the Fed backs off, whether by its design or due to inflation, slower economic growth, or massive debt overhead, rich valuations will matter.

Today, I share my favorite stock market valuation chart with you. It bluntly suggests that a 43.8% correction is required to get us back to what is considered “fair value.” Will it happen? Don’t know. A 26.3% correction gets us back to what is considered “overvalued.”

What is clear is that we sit at one of the most overvalued levels in history.

 

 

The risk of disappointment is high. And so are the costs of being “willfully blind” to the risks.  Consider that 50% of US GDP comes from Small business.  Yet, COVID has decimated small business.  See below:

 

 

Home Sales in the US

 

The [U.S.] Census Bureau said that new home supply remained at 3.3 months in October. This means that, at the current sales pace, it would take 3.3 months to sell all newly constructed homes on the market. This is the lowest level for new home supply since the Census Bureau began tracking the data in 1963.

Take that in for moment.

Compared with October 2019, the Census Bureau said new home sales rose 41.5%. That’s good for an annualized number just shy of 1 million new homes sold for the year.

We see a number of contributing factors here. First, record-low mortgage rates – less than 3% interest on a 30-year loan – are making it easier to “buy more house for the same amount of money”.

At the same time, the youngest of the millennials – now our country’s largest living adult generation – are looking to buy homes and start families. This generation makes up the largest percentage (38%) of homebuyers in the U.S. today, according to the National Association of Realtors.

A lot of people are rethinking whether they want to be living in a city or not, and are looking to move out into the suburbs or the country.

The biggest driver though is low mortgage rates:

 

 

What about “affordability”?

This chart below distills the three pieces that make up affordability into one simple number. A reading of 100 means a typical person can afford a typical house in the U.S. A reading of 150 means he could afford 150% of the typical home price. So higher numbers (low on the chart) mean housing is more affordable.

The market isn’t as cheap as it was in say, 2012, when both house prices and interest rates were incredibly low. But today, this metric from the National Association of Realtors – the Housing Affordability Index – reads roughly 160. That means buyers generally have 1.6 times the money they need to buy (or refinance).

 

 

Tax Planning Before Year End

 

Any low-cost basis stock or real estate?  If so, you have 2 weeks for Long Term Capital Gains tax at 15% before it goes up next year.  Check with your tax advisor, you may benefit by selling low cost basis stock or real estate, pay the capital gains at 15% and establish a higher basis.

  • Roth Conversion this year before year end 2020.  Make sure to stay on track for using this year to convert another chunk of your IRA to Roth.  Make sure to not raise your tax bracket by doing so.
  • The SECURE Act eliminated the stretch IRA. The estate tax exemption and lifetime gift exclusion could be substantially reduced next year, and the step-up basis may be eliminated, which could hit heirs with substantial capital gains taxes. Annual gifting and split gifting could be more important than ever. To help maximize inheritance and minimize potential estate tax concerns, review gifting strategies and beneficiary designations. High-net-worth clients may want to consider leveraging the lifetime gift exemption to reduce their taxable estate. If both parents and grandparents are wealthy, consider transfers to grandchildren in anticipation of changes to the generation-skipping tax.

 

US Economy

 

  • The NFIB small business sentiment index declined last month.
  • The pandemic spike put pressure on small firms, and more pain is coming this winter.
  • Small companies’ outlook for general business conditions soured.
  • Hiring plans remain robust.
  • Businesses are increasingly saying that inventories are too low.
  • A separate survey suggests that a large percentage of small firms view additional government funds as critical for their survival.

 

  • Small businesses have been boosting prices, which is signaling higher inflation ahead.
  • The third-quarter increase in productivity was adjusted down.
  • Will the pandemic-induced investment in technology boost productivity going forward?

 

 

  • China’s trade surplus with the US hit a record high driven by America’s consumer demand.
  • Demand for factory workers hit a new high.
  • The U. Michigan consumer sentiment index surprised to the upside despite the worsening pandemic. Economists attributed the improvement to the vaccine news and higher stock prices.
  • Economists increasingly see upside risks to GDP forecasts for the next twelve months. But the recovery is expected to be uneven.

 

Debt

 

The Bipartisan Policy Center tracks the federal deficit on a monthly basis. The chart below illustrates the deficit’s monthly progression for 2017 to 2020 (estimated). This information comes directly from the U.S. Department of the Treasury and the Congressional Budget Office (“CBO”). The chart speaks for itself.

 

 

The CBO is projecting a 2020 deficit of $3.3 trillion. This is the federal government. The source of the increase is obvious – the COVID-19 pandemic has catalyzed massive stimulus spending.

Global debt levels continue to climb.

 

 

 

Jobs Report

 

When you adjust for Labor Force Participation Rate (LFPR), which has fallen sharply, millions are neither working nor seeking work, often because they have young children who are out of school. If LFPR had held steady, the unemployment rate would now be almost 10% and (as of November) rising. A potentially ominous sign.

 

COVID Update

 

This Bloomberg infographic is kind of busy but it packs a lot of data into a small space. Each box shows a graph of COVID-19 per capita hospitalizations for the 50 states plus DC and Puerto Rico. They are ordered from highest to lowest and the background color denotes whether that state’s hospitalizations are trending up or down.

 

 

Naturally, the data comes with caveats. It is self-reported by the states and the quality may vary. Some patients may have tested positive for COVID-19 but be hospitalized for other reasons. Nonetheless, it shows a lot of variation within the US. As of December 5, Nevada had 581 hospitalizations per million and rising, while Hawaii had 40 and was improving. Explaining the difference might reveal some useful practices we could apply everywhere.

How mRNA vaccines work:

 

 

 

 

 

All Content is the Opinion of Brian J. Decker