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Why a stock market already priced for perfection can go a lot higher: Morning Brief

Monday, September 21, 2020

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What we think is ‘perfect’ today doesn’t capture what could surprise us in the future

Stretched valuations have Wall Street strategists torn on what's next for the stock market.

We recently highlighted some strategists who are convinced the S&P 500 (^GSPC) can power to 3,600.

But on Thursday, Barclays’ top U.S. equity strategist warned that the market was already "priced for perfection" and predicted the S&P 500 would tumble to 3,100 by year end.

"Measures of equity valuations are now at 2000 dot-com bubble levels and appear to be pricing in an ideal scenario where there will be an extremely strong cyclical recovery driven by a vaccine, the market shares gains from the 'Resilient' (large cap tech) stocks will accelerate, and US presidential elections will not pose a significant headwind to risky assets," Deshpande said. (Check out recent issues of the Morning Brief for further discussion on the vaccine, large cap tech stocks, and the presidential elections.)

In other words, he's arguing that everything in the near future needs to go right to justify where prices are today.

Deshpande’s 32-page research note has quite a bit of detail and nuance. But he’s far from alone among market skeptics who believe all the good news to come in the near future is already priced in.

So, who’s right?

Unfortunately, it’s as close to impossible to accurately predict what stocks will do over such a short period of time. History has shown even very stretched valuations aren’t a reliable indicator of the direction of stocks in the near term. Indeed, at least one prominent Wall Street strategist went as far as to withdraw his S&P 500 target, arguing “there is no precedent to how high valuations can go.”

Better than perfect?

We would, however, caution against banking too much on the idea of a market that's "priced for perfection." Because it assumes we know what makes for a perfect scenario. How we define perfection today is limited by what we think we know today.

Every day in markets, we hear phrases like "better than expected" and "upside surprise" to explain why stocks are doing what they do. In other words, not only can things go perfectly as planned, but they can go even better than that.

As we wrote in July, history is littered with surprises that powered the stock market to levels that blew away expectations.

And so it may just be a mistake to forget that something or some things could happen that we don’t expect that forces us to rethink our investing framework and raise the bar for how we define perfection.

Investing in stocks is a fantastically treacherous and exciting exercise. Just in the past year, we’ve seen how things can go all wrong for investors. But we’ve also learned that even against the most challenging economic backdrops, some things can blow away expectations (see tech, housing, golf...) and power stock prices higher.

By Sam Ro, managing editor. Follow him at @SamRo

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