Studying the market, one learns many a thing that often flies in the face of logic. The reason is the market is not a “pure” game; forces are constantly trying to manipulate it and if the forces are powerful enough, they succeed. Now, this reality flies in the face of logic because one can logically ask, “Then why play the market, if forces can move it this way and that when it suits them?”
The answer is simple – because if you understand this, you can go where the money flows (or does not flow). For example, back in 2008, when oil was pushing $130 per barrel, Goldman Sachs was out there pushing hard that oil was going to $200.
Clearly, since after the fact, we found out that Goldman Sachs owned a large share of the oil-speculation market, we can see why they were telling the world oil was going to $200 – it benefitted them to have the price of oil go up.
Given this understanding, here again, Goldman Sachs is telling us something and we should be wary.
- Seven months after the Federal Reserve warned that valuations of some smaller, biotechnology and social-media stocks may be “stretched” in the U.S., Goldman Sachs Group Inc. is using the same word to describe the whole shebang.
Yes, the big firm is out there telling us that the market is overvalued, over stretched, and, perhaps, ready for rather large correction (crash?), and they base this analysis on …
- “The only time during the past 40 years that the index traded at a higher multiple was during the 1997-2000 Tech Bubble,” Goldman’s chief U.S. equity strategist David Kostin and colleagues wrote in a Feb. 20 report.
Well, as we all know, facts and statistics can be shaped to form impressions and perceptions about the market, and Goldman Sachs’ use of the above example seems to be exactly that, an attempt to move the market because …
- “Stretched” valuations sound scary, but here’s something that may be even scarier: missing out on an 80 percent rally over the following three years because you got out of stocks when the market looked stretched. That would’ve been the case in 1997 when the Standard & Poor’s 500 Index first got to the valuation of 17.3 times estimated earnings for the next 12 months, which is also where it’s trading these days.
So, even after the warnings in 1997, the market continued to perform well for over three years at the then-high multiples. Something to keep in mind about this is those multiples (corporate profits) ran into a recession, meaning, they went higher because corporate profits diminished as the economy receded.
Here is something else to consider …
- What’s happened since the Fed’s remarks about stretched valuations seven months ago? Well, the S&P 500 has gained almost 7 percent, the Nasdaq Composite Index is up 12 percent and the Russell 2000 Index of small caps is more than 5 percent higher. While the Solactive Social Media Index is down about 2 percent since then, the Nasdaq Biotechnology Index has surged more than 30 percent.
My point here is that using these analysts (Goldman Sachs and others) as a guide to future market movement is not necessarily good policy. They either are pushing the market in a direction, or they are drawing erroneous conclusions from selected data. Me thinks it is a little of both all the time.
The reality is always the same – the economic and market fundamentals are the important gauge for future market movement. As long as the US economy is growing, it is likely corporate profits will continue to grow. And, as long as corporate profits continue to grow, it is likely the market will continue onward and upward, especially if rising corporate profits bring the multiples back down.
In the end, it is good to keep an eye of the multiples, but always juxtapose those against the reality of the current economic situation. Right now, there is now reason to suspect that the US economic fundamentals will change to the negative, especially with Europe and Japan coming back into the growth fold.
Trade in the day; invest in your life …
