Goldman Sachs says we may see a 10% pullback in stocks. That's no big deal, says one strategist, and he has a 70-year chart to show why.
Goldman Sachs has a warning on stocks: They're too high.
According to David Kostin, chief US equity strategist at Goldman Sachs, the odds are in favor of a 10% pullback with equities "lofty by almost any measure". Kostin l lists ten such measures in his "Weekly Kickstart" note:
The current valuation of the S&P 500 is lofty by almost any measure, both for the aggregate market as well as the median stock: (1) The P/E ratio; (2) the current P/E expansion cycle; (3) EV/Sales; (4) EV/EBITDA; (5) Free Cash Flow yield; (6) Price/Book as well as the ROE and P/B relationship; and compared with the levels of (6) inflation; (7) nominal 10-year Treasury yields; and (8) real interest rates. Furthermore, the cyclically-adjusted P/E ratio suggests the S&P 500 is currently 30% overvalued in terms of (9) Operating EPS and (10) about 45% overvalued using As Reported earnings.
But, is Goldman Sachs right? John Stephenson, portfolio manager at First Asset Investment Management, doesn't believe so.
"Goldman is such a scene-stealer," says Stephenson. "You might be waiting years for a pullback and I think you will be. The reason is the economy is starting to work in the favor of stocks."
According to Stephenson, an expected 3% growth in GDP for 2014 should translate to a 7.5% growth in corporate earnings. As well, Stephenson believes sizable corporate cash holdings and US economic strength relative to the rest of the world will make American markets attractive in 2014.
"The market's going higher," says Stephenson. "Goldman's wrong on this one. I think you stay long and strong this market and you'll be well served."
(Read: US stocks rise with retail sales)
Talking Numbers contributor Richard Ross, Global Technical Strategist at Auerbach Grayson, says Goldman's expectation of a 10% correction is not a big deal.
"A 10% correction is really nothing special," says Ross. "You could be very bullish on this market and still get a normal 10% correction. So, that's not a particularly bold call here."
"Valuation in and of itself is a very poor market timing tool in the short-term," says Ross on the idea that overvaluation could lead to drop in the overall market. "Lofty can go even higher and become even loftier."
Yet Ross believes stocks may go even higher in the long-term. Using a chart going back 70 years, he shows the similarities between the most recent 13 years and a 13-year range four decades ago.
"Since 1940, we've essentially had 20-year bull markets – over 1300% rises in the process – punctuated by 13-year sideways trading ranges," says Ross. "In fact, we've just broken out from the second of such trading ranges. I think we're going to see another fantastic multi-year – perhaps multi-decade – bull run which has just started now."
To see more of Stephenson's analysis and Ross' 70-year chart on the S&P 500 and how now looks eerily like the start of a prior major move in the market, watch the video above.
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