This past week, I read an article about UBS’ take on where the market is heading over the next 12 months or so. UBS is forecasting another 9% gain for the S&P 500 in 2018, which would mark the 10th straight year of positive returns if true. Also discussed were two of the biggest fears gripping Wall Street right now, which I wanted to address individually.
“Stocks are overvalued, and global equities are in a bubbleâ€
The market is expensive compared to long-term historical averages, but just how expensive? Thanks to several strong quarters of earnings and revenue growth, the forward P/E on the S&P 500 now has come down to around 19. Given reasonably strong GDP growth, solid earnings and low inflation, this number isn’t that unreasonable. The Shiller P/E, which looks at inflation-adjusted earnings over the past 10 year, suggests the market has only been this expensive at one other point in history – the dot-com bubble.
At this point, I think the forward P/E gives a better indication of where the economy and the markets are at. But it’s difficult to find a short-term catalyst that could move the markets significantly lower. Keep an eye on interest rates though. High valuations can be supported as long as rates remain low. If rates start shooting higher, a correction could be in the offing.
“Central-bank tightening will suck the life out of stocksâ€
This is what I’ve said is the most likely cause for a short-term pullback. It really depends on how fast the Fed decides to lift rates. It seems very likely we’ll see a rate hike in December, while the Fed Dot Plot suggests three more moves higher in 2018. Janet Yellen has suggested several times that the Fed will lift rates gently and will only gradually start drawing down the balance sheet. If that holds true, there’s no reason to think that interest rates could normalize while the bull market continues. A Fed that moves too quickly could end up stifling economic growth, but it seems pretty determined to not let that happen.
