On May 12, analysts at Goldman Sachs Research projected that the S&P 500 would increase by approximately 11 percent, reaching 6,500 in the following year. A month in, the S&P 500 has climbed from 5,844 to 6,045, reflecting a gain of about 3.4 percent.
This optimism stems from reduced concerns over U.S.-China tariffs and a more promising economic growth outlook. Goldman’s economists estimate a mere 35 percent risk of a U.S. recession within the next year, projecting a GDP expansion of 1.6 percent.
David Kostin, Goldman’s chief equity strategist, raises the pivotal question: “Who will absorb the increased tariffs?”
Will producers in China bear the costs? Will retailers like Walmart absorb the impact amidst already narrow profit margins? Or will consumers ultimately face higher prices?
These answers may remain elusive for another quarter or so. First quarter earnings revealed a robust 12 percent year-over-year growth, but this was recorded before the escalation of trade tensions. The second quarter reports will likely begin to reflect the effects of diminished demand and shrinking profit margins.
There’s also the risk that negotiations with China could falter entirely. What implications would this hold for Goldman’s predictions?
The S&P 500 could continue its upward trajectory even amid a weakening economy. It’s well-known that both Wall Street and President Trump are keen on a rate cut.
Perhaps concerning economic indicators, such as sluggish growth and increasing unemployment, will prompt the Federal Reserve to lower rates. Such a move could be interpreted as positive news for stocks, satisfying countless investors seeking reasons to buy.
A New Bull Market is Born?
The excitement on Wall Street is palpable. The S&P 500 recently surged 20 percent above its April 8 low, officially inaugurating a new bull market. The fears surrounding tariffs from early April have dissipated like fog in the sunlight.
The CNN Fear & Greed Index indicates a sentiment of greed. This suggests that investors are displaying high optimism and are more willing to embrace risk, signaling strong buying pressure that can elevate stock prices further.
Furthermore, the American Association for Individual Investors (AAII) survey is shifting towards bullishness. As of June 11, the percentage of bearish investors declined to 33.6 percent—though still above the historical average of 31 percent, it’s a substantial decline from the 61.9 percent recorded in early April. It appears that retail investors are being lured back into the market.
However, we contend that this isn’t a true market recovery. It is evidently not rooted in solid economic fundamentals. Instead, it appears to be the same old bull market driven by an increase in debt levels.
The prospect of interest rate cuts by the Fed serves as additional fuel for this rally. President Trump is fervently urging Fed Chair Jerome Powell to enact a full percentage point cut, desiring Rocket Fuel!
Though Powell has resisted Trump’s pressure and criticisms thus far, he is likely to acquiesce eventually. A single unfavorable economic data report could provide the justification he needs. Then, Trump might achieve his goal—though the outcomes may not align with his expectations.
What Your Broker Won’t Tell You
Rising stock prices against a backdrop of declining economic fundamentals represent a particularly deceptive type of bull market. This situation rewards reckless speculators while penalizing cautious investors. It is crucial to recognize the inherent risks.
The financial services industry frequently wants you to believe that the stock market can maintain its upward momentum indefinitely, pointing to headlines, quarterly earnings, and the S&P 500’s performance.
Simultaneously, they overlook the genuine underlying market fundamentals. Those who take a moment to assess actual market valuations soon realize that the escalating S&P 500 index is built on a fragile foundation.
Evaluating the Cyclically Adjusted Price-to-Earnings (CAPE) Ratio provides insights often disregarded by brokers.
The standard Price-to-Earnings (P/E) ratio is straightforward, showing how much you pay for a dollar of a company’s earnings. However, earnings can be volatile; a single strong quarter or weak year can skew the P/E ratio. That’s why Robert Shiller developed the CAPE ratio.
Rather than relying solely on the most recent year’s earnings, the CAPE ratio divides the current S&P 500 price by the average of the past ten years of inflation-adjusted earnings. This approach smooths out volatility, yielding a clearer picture of whether stocks are genuinely undervalued or overvalued.
What insights does this crucial metric provide today?
As of market close on June 12, the S&P 500’s CAPE ratio stood at 37.05. For context, the historical average CAPE ratio for the S&P 500 since 1881 is 17.24.
The CAPE Crusader Unveils a Bubble
A CAPE of 37.05 signals a market price more than twice its long-term average, indicating extreme overvaluation rather than a minor pricing discrepancy. This situation is indicative of a bubble.
Historically, whenever the CAPE ratio has reached such high levels, the subsequent ten-year investor returns have been dismal—often yielding negative real (inflation-adjusted) returns.
It is essential to note that the CAPE ratio is not a precise market timing tool; valuations could become even more inflated in the coming months. Nevertheless, it offers insights into potential long-term returns, currently suggesting that investors are paying a premium for assets that are unlikely to provide satisfactory returns for many years, if not decades.
In the upcoming months, the anticipation of Fed rate cuts could further exacerbate the existing bubble. Lower borrowing costs from central bank policies often fuel speculative behavior, potentially driving the S&P 500 index even higher in the short term. Yet, such gains would likely come with overwhelming underlying risks.
The current CAPE ratio is nearing the dot-com bubble peak of 44.19 in December 1999, significantly above the 31.48 peak reached just before the 1929 crash—both of which culminated in significant downturns.
As the S&P 500 moves toward new all-time highs in the days ahead, the CAPE crusader’s warning is unequivocal. Investors are currently paying absurd bubble prices for earnings.
Caveat emptor.
[Editor’s note: Trump Sends Strange “Coded” Message to Conservatives (Liberals Can’t Figure It Out!). Democrats are voicing concerns about illegality in Trump’s actions, yet conservatives comprehend precisely what he aims to convey. Click here to discover what we foresee next for Trump’s “Master Plan”.]
Sincerely,
MN Gordon
for Economic Prism
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