“The strong economic recovery will not get interrupted by inflation or a credit crunch, and the market will soon reach 4,500.” – Ed Yardeni via Advisor Perspectives

After discussing BofA’s view of why the market could drop to 3800,  I thought it fair to discuss a more optimistic view.

BofA’s view of a market correction was a function of the more exuberant “optimism” in the market.

To wit:

“This analysis is interesting, particularly when analysts are rushing to upgrade both economic and earnings estimates.”

“More importantly, investors are incredibly long-biased in portfolios, with equity allocations reaching some of the highest levels in history.”

What Subramanian questioned is whether all the “good news” is already “priced in?”

“Amid increasingly euphoric sentiment, lofty valuations, and peak stimulus, we continue to believe the market has overly priced in the good news. We remain bullish the economy but not the S&P 500. Our technical model, 12-month Price Momentum, has recently turned bearish amid extreme returns over the past year.”

So, with BofA’s context in place, what is Yardeni seeing so differently?

S&P 500 Earnings Revisions, 1990 - 2020

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Yardeni’s Outlook

Equity Allocations

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Moral Hazard

The ‘stability/instability paradox’ assumes that all players are rational, and such rationality implies avoidance of destruction. In other words, all players will act rationally, and no one will push “’the big red button.’”

Importantly, what Hussman addresses when he says investors psychologically rule out the possibility of price declines is “moral hazard.”

What exactly is the definition of “moral hazard.”

Fed Balance Sheet vs. S&P 500, 2018 - 2020

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While Fed officials tacitly deny any correlation between their monetary interventions and the stock market, the evidence is quite clear.

However, as stated, the consequences of monetary policy longer-term gets set aside for the short-term benefits of inflated “psychology.”

The Flies In The Ointment

I would be remiss in not briefly addressing some of the concerns in Yardeni’s views.

Productivity is deflationary. 

As I discussed in “The Roaring ’20s Aren’t Coming:”

“The critical distinction between the technology of the ’20s and today is stark. When technology increases productivity and output while simultaneously increasing demand by increasing ‘reach,’ it is beneficial.

However, when technology improves efficiencies to offset weaker demand and reduce labor and costs, it is not.”

Furthermore, a sustained spike in inflation, which drives rates higher, will negatively impact both the markets and the economy.

As Michael Lebowitz noted in “What Interest Rate Will Matter,” rate increases have a history of financial events.

Stock Bond Ratio vs. S&P Index, 1997 - 2021

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“Looking back over the last 40 years each time interest rates reach the upper end of its downward trend, a financial crisis of sorts occurred. The graph below charts the steady decline in rates and GDP along with the various crisis occurring when rates temporarily rose.”

“Notice, as time goes on it takes less and less of a rate increase to generate a problem. The reason is the growth of debt outpaces the ability to pay for it.”

Productivity & Wages in The "New-New Normal", 2000 - 2021

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Yes. Valuations Are Expensive.

While Yardeni suggests valuations are cheap, there is little evidence that such is the case. Most of the assumption is that earnings and the economy will “catch up” with prices. Such would suggest that prices remain stagnant during that process, yet Yardeni assumes prices will surge to 4500 in 2021, eclipsing the benefit of assumed growth. 

Therefore, valuations are not only high by historical standards but will remain high as prices rise along with economic and earnings growth. The consequence of over-paying for valuations today is substantially lower long-term returns from asset classes in the future. The eponymous GMO noted such in their most recent 7-year forecasts.

Furthermore, given the extremely high correlation between stocks and bonds, a level of extreme not seen since the “Dot.com” peak, future outcomes seem poor.

10 Year Yields and Secular GDP Growth, 1977 - 2021

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7-Year Asset Class Real Return Forecasts

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If you agree with Dr. Yardeni, the prescription is

If you agree with Dr. Yardeni, the prescription is simple. Buy stocks.

However, as Mark Hulbert recently noted:

“I have no idea whether the stock market is forming a bubble that’s about to break. But I do know that many bulls are fooling themselves when they think a bubble can’t happen when there is such widespread concern. In fact, one of the distinguishing characteristics of a bubble is just that.

So, what should you do if you are close to retirement?

“It’s important for all of us to be aware of this bubble psychology, but especially if you’re a retiree or a near-retiree. That’s because, in that case, your investment horizon is far shorter than for those who are younger. Therefore, you are less able to recover from the deflation of a market bubble.” – Mark Hulbert

You have a choice. But, for now, Yardeni is correct.

Just remember:

“All bull markets last until they are over.” – Jim Dines

The post Technically Speaking: Yardeni – The Market Will Soon Reach 4500 appeared first on RIA.

S&P500 Deviation 52 WMA, 1960 - 2020

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