When the head of major financial institution voices his or her concerns over the market, investors tend to sit up and listen. More often than not the signs have been there all along, but in today’s increasing frenetic society it takes a “voice from on high” to catch people’s attention.
That’s what happened earlier this week when speaking at a conference in Germany, Goldman Sachs (GS) CEO Lloyd Blankfein shared that he was “unnerved” by things going on in stock market. The comment, which came at the end of the question and answer session of his presentation, amounted to the following:
An old Wall Street firm’s slogan was, “When E.F. Hutton talks, people listen,” but in order to properly understand Blankfein’s current unease let’s review the following:
1. “Things have been going up for too long.” While there have been modest pullbacks in the market, such as the ones in late 2014 and the second half of 2015, a longer view shows the major averages have moved sharply higher over the last five years. Before factoring in dividends, the S&P 500, a key benchmark of institutional investors, is up more than 70% since September 2012.
2. If we track things back to March 2009, when the market bottomed out during the Great Recession, the timeframe for the current “recovery” has been more than eight years, or more than 100 months. By comparison, the average economic expansion over the 1945-2009 period spanned 58.4 months. In other words, the current expansion is rather long in the tooth and there are signs in the data that remind of us this.
While this has likely been aided by the Fed’s aggressive monetary policy, the bottom line is that at some point the current expansion will come to an end. As the Fed looks to unwind its balance sheet and get interest rates closer to normalized levels, we’re reminded that the central bank has a track record of boosting interest rates as the economy heads into a recession.
3. Coming into 2017 there was a wave of market euphoria surrounding newly elected President Trump, with high hopes for what he and his team would accomplish. Over the last few months, the administration has issued a number of executive orders, but there has yet to be any progress on tax reform or infrastructure spending. The risk is expectations for these initiatives are once again getting pushed out, with tax reform, originally slated for August, now anticipated near the end of 2017. The risk is the underlying economic assumptions that powered revenue and earnings expectations for the second half will need to be reset.
4. As the stock market has moved higher, so, too, has its valuation. As I write this, the S&P 500 is trading at 18.7x expected 2017 earnings versus its five and 10-year average P/E multiples of 15.5x and 14.1x, respectively. In 2015 and 2016, earnings expectations were revised lower during each year until annual EPS growth was nil. With economic data once again leading the Atlanta Fed to reduce its GDP forecast, we are seeing downward earnings revisions to EPS estimates in the back half of 2017.
5. Since Aug. 1, shares of utilities have moved higher while financials and consumer discretionary stocks have fallen. Not a positive sign for market watchers with a focus on breadth.