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Written by: Tim Pierotti
Last week, the macro team at one of the big investment banks wrote to clients that, “We are lifting our 2024 year-end price target for the S&P 500 to 5700 from 5300 – a nervous raise.” The following pages discuss that the market looks “overbought”, “sentiment looks frothy”, and that valuations appear “difficult to justify”. They are not alone in their fecklessness. Investment banks up and down Wall Street will raise price targets on the market and individual companies as long as prices continue to lift. This is how the game is played. We would all like to believe that these financial “Masters of the Universe” actually make predictions, that teams of analysts scrub the numbers and debate the merits of the bull and bear cases and come out with a conclusion derived from actual conviction. That would be naïve. There are exceptions of course, but they are increasingly rare. Wall Street narratives and recommendations start with the answer that best suits their careers and their clients and find the justification secondly. It’s one thing to be constructive on stocks or markets when the trend is weak, but staying bearish amid a melt-up is career suicide.
As someone who spent seven years running product for Wall Street equity research departments, I can assure you that price targets are essentially meaningless. If the price of the stock goes down so will the target. If the price of the stock goes through the target, in all likelihood, the analyst will simply raise the target and back into the justification by assuming higher future multiples.
In fairness, the trend following is prevalent not just among the analysts and strategists, but also among the managers of mutual funds and hedge funds. As the chart from Citigroup below illustrates, as prices move higher, positioning just gets longer. It’s called chasing performance and when indexes are pushing higher with historically narrow breadth, portfolio managers who hope to keep their lucrative employment hold their collective nose and buy more Tesla and Apple.
As the fine print states, according to Citi’s analysis, “euphoria levels generate a better than 80% probability of stock prices being lower one year later”. In other words, when everyone loves the market, it probably makes sense to take off some risk.
Our view of the market has been consistent since February of this year. We think that the risk-on environment, driven by money printing, unprecedented fiscal excess and the generational wealth transfer will hold until it is clear that a recession is happening or there is a reacceleration of inflation that pushes long-term interest rates higher. We concede that valuation doesn’t matter until it does. In other words, the fact that the price to sales ratio of the market weighted S&P has only been higher in the telecom and internet bubble of 2000, doesn’t mean that the market can’t go higher. It does, however, mean that your risk/reward isn’t very good.
Let’s be careful out there. Trailing stops are your best friend.
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