Have Stocks 'Reached a Permanently High Plateau?'
August 23, 2013
Chad Karnes, ETFguide.com
The definition of groupthink is, “a psychological phenomenon that occurs within a group of people in which the desire for conformity in the group results in an incorrect decision-making outcome. Members try to minimize conflict and reach a consensus decision usually without evaluation of alternative viewpoints.”
There may not be a better example of this than Wall Street's analysts.
Wall Street’s Modus Operandi
Many Wall Street “professionals” have S&P 500 price targets going up, up, and away. Price targets continue to be raised as the markets rise and strategists chase price. If you look at Wall Street analysts’ price targets history, rarely, if ever do they assume the markets will decline, even though we all know that the markets do indeed decline as well as rise.
Even in 2008 Wall Street kept earnings targets above the market reality as the black line in the chart below shows. To hide this fact and cover their tracks, they upped the amount of projections they provided, coming out with new now lowered price and earnings “forecasts” every two weeks in order to keep up with the rapid market (NYSEARCA:VTI) declines.
WATCH: A Dynamic Way for Examining the VIX
The chart below from FactSet shows Goldman Sachs’s (NYSE:GS) current S&P (SNP:^GSPC) price projections and their current expectation of a $2100 2015 price target based on earnings growth continuing, well, into perpetuity.
Conflicts of Interest
For these strategists it does not pay to go against the grain. It is much easier to keep their job being wrong when everyone else is wrong, than it is to have an unbiased and unique view of the markets.
This is the definition of groupthink as Wall Street rewards conformity.
For us at ETFguide.com, we are allowed the luxury of providing unbiased advice without conflicts of interest. This is why we know that earnings have already peaked out and won’t hit their 2013 or 2014 estimates (just as they never hit their 2011 or 2012 targets) as outlined in my recent article, “Ignore Earnings Estimates”. For one, history just does not support many examples of earnings rising for so long without at least a 20% pullback.
This however is only one of many reasons to not agree with Wall Street’s groupthink of ever rising stock markets.
In the July issue of the ETF Profit Strategy Newsletter I analyzed earnings growth going back to the 1800s
and found that Goldman’s stance of ever increasing earnings is
preposterous. Check out the following
graph of actual earnings growth over time.
If one thing is for sure, it is that earnings do not grow forever into perpetuity. There is indeed a business cycle that takes over as earnings instead are extremely cyclical.
Year over year earnings have declined 37% of the time throughout history and have fallen more than 20%, 10% of the time. This directly affected share prices as quarterly S&P prices (NYSEARCA:SPY) have declined year over year a similar 37% of the time and have been down more than 20%, 7% of the year over quarters throughout market history.
A normal earnings decline of 20% could easily pull the market back to 1200.
Why else S&P 1200?
Over the history of the U.S. stock market, prices have gained about 5%/year excluding dividends. Dividends have added another 3-5% on average resulting in the historical 8-10% expectation of equity market returns.
The final chart is one I created showing the long term logarithmic trend of the Dow (NYSEARCA:DIA) over its 100 year history. There is a clear long-term projection.
It is obvious there are better times to be long term buyers and better times to be long term sellers.
When prices have reached the upper end of the returns spectrum (like in the 20s and 60s shown in red in the chart), long term investors were better suited to take profits or move to safer assets such as Treasuries (NYSEARCA:TLT), as the equity markets (NYSEARCA:IWM) offered very low or even negative long term returns.
Similarly when prices have reached the lower end of the long term average, such as in the 30s, 40s, and 70s as shown in green in the snapshot below, prices (NYSEARCA:VTI) offered great opportunity. Generally, buying during these times awarded very attractive long term returns, well above the historical 5% average (shown in blue).
The full chart and analysis is reserved for subscribers, but with an S&P near 1700, prices (NYSEARCA:SDS) are now well beyond their historical average range.
At ETFguide.com we prefer biases based upon reality and to allow the data help us find our next trading opportunities. This is why back in May we warned how falling lumber prices would lead the homebuilder stocks (NYSEARCA:XHB) down.
That has already started to play out as the homebuilders (NYSEARCA:ITB) continue to lag the broader market and are now down over 5% since then. They may even have a lot further to fall based on a technical pattern I am following in our ETF Technical Forecast.
The ETF Profit Strategy Newsletter examines more reasons why S&P 1200 is an acceptable downside target using our four pronged approach of fundamentals, technicals, sentiment, and common sense. For a market that has gotten well ahead of itself, 1200 is a logical first stop on the way down.
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