Odds of a 1990s-like market boom have increased after Fed rate cut, in investment strategist Ed Yardeni’s view
Warren Buffett has been raising cash probably because his Buffett Ratio – measured as the $S&P 500 Index (.SPX.US)$‘s price index to forward sales – is in record-high territory.
We’ve focused on three U.S. stock-market scenarios since the start of the decade: a 1920s-style “Roaring 2020s,” a reprise of the 1990s stock-market melt-up and a rerun of “That ’70s Show” with geopolitical shocks causing oil prices and inflation to spike.
Until now, our subjective percentage probabilities of 60/20/20 for these three alternative outlooks, respectively, haven’t changed. But Fed Chair Jerome Powell is forcing us to change them now, to 50/30/20.
In his Aug. 23 Jackson Hole, Wyo., speech, Powell signaled that he was pivoting from inflation hawk to employment dove. There was no doubt about this remarkable metamorphosis on Wednesday, when he must have convinced his colleagues on the FOMC to lower the federal-funds rate by a half of a percentage point rather than a quarter.
As we noted about the rate cut: “The FOMC had its first dissent since 2022 at this meeting. Fed Governor Michelle Bowman voted for a smaller 25bps rate cut. But the Fed’s dot plot, updated in its new SEP [Summary of Economic Projections], suggests dissent was much greater. Two participants favor not reducing rates again this year, and another seven see just one 25bps cut later this year.”
At Jackson Hole, Powell left no doubt when he said, “We will do everything we can to support a strong labor market as we make further progress toward price stability.” Stock prices soared to new record highs on Wednesday after Powell and company delivered the 50-basis-point rate cut and signaled many more to come until the federal-funds rate falls to 2.9%, which they currently deem to be the long-run neutral interest rate.
At his presser on Wednesday, Powell delivered the stock market to the Promised Land, where “strength in the labor market can be maintained in a context of moderate growth and inflation moving sustainably down to 2%.”
Investors shouted, “Hallelujah.”
The question is whether exuberance is quickly turning from the rational variety to the 1990s irrational version.
The question is whether exuberance is quickly turning from the rational variety to the 1990s irrational version. S&P 500 forward earnings per share should continue to rise to new record highs, especially if the Fed’s aggressive easing heats the economy, which has been growing at a steady and moderate pace in the face of Fed tightening.
So, earnings should continue to justify rational exuberance. The problem is valuation. Warren Buffett has been raising cash probably because his Buffett Ratio (measured as the S&P 500’s price index to forward sales) is in record-high territory at 2.83 during the Sept. 19 week.
Somewhat less irrational is the S&P 500’s forward P/E. It’s elevated at 21.1. But it isn’t in record territory, yet. Its divergence with the S&P 500 forward price-to-sales ratio is attributable to the index’s rising profit margin causing earnings to rise faster than sales.
So, what about our S&P 500 price targets? We are still expecting S&P 500 earnings per share to be $250 this year, $275 next year and $300 in 2026. Our S&P 500 forward earnings projections for the ends of 2024, 2025 and 2026 remain at $275, $300 and $325. We have even more confidence in these estimates now that the Fed is so committed to averting a recession.
We’ve been using a forward P/E of 21.0 to get our year-end S&P 500 targets, respectively, of 5,800, 6,300, and 6,800 for 2024, 2025 and 2026. We’ve decided to stick with these targets but acknowledge that the risk of a melt-up has increased, as noted above. In a melt-up scenario, the S&P 500 could soar above 6,000 by the end of this year. While that would be extremely bullish in the near term, it would increase the likelihood of a correction early next year.
Ed Yardeni is president of Yardeni Research Inc., a provider of global investment strategy and asset-allocation analyses and recommendations. Eric Wallerstein is Yardeni Research’s chief markets strategist. This article is excerpted from Yardeni Research’s “Quick Takes” for Sept. 20, 2024 – “Raising Odds of a Meltup.” Individual investors can read Yardeni Research reports here.