Bubble Wubbles: S&P500 Going to 5,000 in 2021

How I Learned to Stop Worrying and Love the Bubble (Talk)

OMG the stock market is insanely overvalued – worst in all history save for Tulip Mania (and surpassing that ultimate is not too far away)! Umm, no. No, it is not. I wubbles (i.e. love) all the market bubble talk though. Helps make me richer as we climb the wall of worry. How can I be so cavalier in the face of such overwhelming evidence of the supposed “every asset bubble?” I look instead in the right place.

This time it is different. Haven’t we all heard and lived through those times? They didn’t end up well in history…not one single time. So what makes this time actually different? The Federal Government does. As written over the summer (in which I called for 4,000 S&P500 that we have almost now reached), traditional valuation measures fail when government becomes a massive financial backstop.

Regression Valuation Model Quantifies Federal Government Impact

 Over last 60 years though, one method stood the test of time that does not depend on traditional inputs: regression. It too requires inputs, but they are sometimes more discernible than traditional measures. To wit, just four inputs rationally predict S&P 500 fair value: Gross Domestic Product (GDP), Money Stock (M2), corporate bond spread, and CPI. And we still think that markets discount earnings?

Regressing just these four factors against the monthly level of S&P 500 since 1959 (i.e. 60 years of data) yields a model with exceptional fit (i.e. 0.95 R2), credibility across factors/model itself (i.e. high t-stats and F-factor significance), and correlation/coefficient alignment. In other words, it is not coincidence and includes a range measure capturing most history (i.e. proxy for 3x standard deviation of residuals):

What does the Regression Valuation Measure Say Now?

Given strong factor causation implied in the model above, it is natural to extrapolate forward to the end of 2021 to determine potential fair value level for the S&P 500. S&P 500 as of February 12th is amazingly just 10% overvalued (assumptions: 6% nominal GDP growth, $22tn M2, 2% corporate bond spread, +3% CPI over the next 12 months). That is not as nice as fairly/undervalued, it is NOT a bubble. 

Indeed, it is nowhere near a bubble. We are now only 2 proxy standard deviations above fair value. This is not remotely close to 16 proxy standard deviations witnessed in latter 1990’s mega-bull market. We are not even at 4 proxy standard deviation overvaluation from September 2020 before the brief correction. In short, stop worrying about a bubble in stocks. It does not exist today…not by a long shot.

Wait a Moment. Thought You Said 5,000 S&P500 is Your Goal Now?

 3x proxy standard deviations from discounted fair value yields about 4,100 S&P500 now – as in today. What if my estimates for 2021 GDP, M2, CPI, and corporate bond spread above are too conservative though? With augmented 2021 estimates of 7% nominal GDP growth, $25tn M2, 1.5% corporate bond spread, and +4% CPI over next 12 months, S&P500 3x standard deviation overvaluation is about 4,500. 

However, investors a year from now will be looking at 2022 estimates, not 2021. Assuming 2022 estimates of 4% nominal GDP growth, $26tn M2, 2% corporate bond spread, and +3% CPI, the S&P 3x proxy standard deviation overvaluation level will be about 4,700, just about -5% shy of 5,000 level. In other words, S&P500 5,000 in 12 months’ time is possible (i.e. +25% above from current overvaluation).

Still Not a Question of Whether to Buy Right Now. Question Remains How Fast?

According to our long-term regressed model for the S&P500, the S&P 500 is incredibly not only not in a bubble but is only moderately overvalued relative to history. Moreover, the S&P500 has the potential to rise another +25% over the next 12 months from current level. Interestingly, this projection increasingly phases out the importance of the Federal Government’s 2020/2021 actions as “normality”’ returns.

S&P 500 has risks: e.g. vaccination rate, economic re-openings, earnings, inflation, sentiment overdrive. A near-term market correction would be natural. However, any market drops in 2021 will likely be amazing Buy-on-the-Dip opportunities. Well, look at me! Perma-bear has become a seemingly perma-bull. Why? Uncle Sam, what lies beyond, and hope for beginning a real 2020’s bubble. Place your bets.

DISCLAIMER: Comments above are not a recommendation to buy, hold, or sell any security. Investing is inherently risky. PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.