Buy the S&P Melt Up Coming | Ed Yardeni and Jimmy Connor

Key Concepts

• Bullish Outlook: A positive sentiment towards the economy and stock market, expecting growth and rising prices.
• S&P 500 Target: Specific price levels projected for the S&P 500 index.
• Earnings Growth: The increase in profits reported by companies.
• Labor Market: The supply and demand for workers, including employment and unemployment rates.
• Federal Reserve (Fed): The central bank of the United States, responsible for monetary policy.
• Fed Funds Rate: The target interest rate set by the Fed for overnight lending between banks.
• Basis Points (bps): One-hundredth of a percentage point (0.01%).
• GDP (Gross Domestic Product): The total monetary value of all finished goods and services produced within a country's borders in a specific time period.
• Productivity: The efficiency with which labor and capital are used to produce goods and services.
• Inflation: A general increase in prices and decrease in the purchasing value of money.
• Tariffs: Taxes imposed on imported goods.
• Trade Wars: A situation where countries impose tariffs and other trade barriers on each other.
• Valuations: The process of determining the current worth of an asset or company.
• Forward Price-to-Earnings (PE) Ratio: A valuation metric that compares a company's current share price to its expected earnings per share in the future.
• Buffett Indicator: A valuation metric that compares the total market capitalization of a country's stock market to its GDP.
• Magnificent 7: A group of seven large-cap technology companies that have significantly driven market performance.
• AI (Artificial Intelligence): The simulation of human intelligence processes by machines, especially computer systems.
• Initial Coin Offerings (ICOs): A fundraising method used by cryptocurrency startups.
• NFTs (Non-Fungible Tokens): Unique digital assets that represent ownership of a specific item or piece of content.
• Cryptocurrencies: Digital or virtual currencies that are secured by cryptography.
• Sports Betting: Wagering on the outcome of sporting events.
• Zero-Day Options: Options contracts that expire on the same day they are traded.
• Dual Mandate: The Federal Reserve's objectives of maximum employment and price stability.
• Neutral Rate: The theoretical interest rate that neither stimulates nor restrains the economy.
• Bond Vigilantes: Investors who sell bonds when they believe government fiscal policy is unsustainable, driving up bond yields.
• Treasury Bills: Short-term debt instruments issued by the U.S. Treasury.
• Stablecoins: Cryptocurrencies designed to maintain a stable value relative to a specified asset or currency.
• Fiscal Excesses: Government spending that exceeds revenues, leading to increased debt.
• DXY (US Dollar Currency Index): An index that measures the value of the U.S. dollar relative to a basket of foreign currencies.
• Commodity Prices: The prices of raw materials such as oil, gold, and agricultural products.
• Fiat Currencies: Government-issued currency that is not backed by a physical commodity.
• Geopolitical Risks: Potential threats to national security and international stability arising from political and international relations.
• Meltup: A rapid and unsustainable increase in asset prices, often driven by speculation and excessive liquidity.
• Structural Trend: A long-term, fundamental shift in the economy or market.

S&P 500 and Economic Outlook

Current Market Position and Year-End Target: The S&P 500 is currently trading around 6,600, ahead of the initial expectation of 6,800-7,000 for year-end. This optimism is driven by the anticipation that S&P 500 companies will earn $300 per share next year, which, when multiplied by a forward PE of 22, aligns with current market levels. However, there's a possibility that earnings could exceed $300 per share, further supporting the bullish outlook.

Long-Term Projections: The speaker maintains a strong bullish stance, projecting the S&P 500 to reach 7,700 next year and potentially exceed 10,000 by 2029, characterizing the current period as a "roaring 2020s."

Economic Resilience and Contrasting Indicators: Despite concerns about tariffs and trade wars in late 2024, the global economy has not slowed down as feared. Instead, corporate earnings in Q1 and Q2 have been exceptionally strong and are expected to continue improving. While labor market indicators have shown weakness, leading the Federal Reserve to lower the Fed funds rate by 25 basis points, the overall economy remains firm. The Atlanta Fed's GDP Now forecasting model indicates a growth rate of over 3%, following a revised 3.3% in the second quarter. This discrepancy between a weakening labor market and strong GDP growth suggests that productivity is compensating for the difference.

Productivity as a Key Driver: Productivity growth is identified as a crucial factor supporting the current economic strength. It explains how the economy can achieve 3% growth with only 1% labor force growth. High productivity also contributes to stable inflation, well-maintained corporate profit margins despite tariffs, and robust real wages.

Tariff Impact and Corporate Margins: Contrary to expectations, tariffs have not significantly squeezed profit margins of American importing companies on a macroeconomic level. While micro-level impacts might exist, overall earnings reports have not indicated widespread negative effects.

Valuations and Market Extremes

Current Valuation Metrics: The S&P 500 is trading at a forward PE of 22, considered a rich valuation. Other indicators, such as the Buffett Indicator (market cap to GDP), are also at extreme levels, exceeding 200%. The price-to-sales ratio for the S&P 500 is at an all-time high of 3. Historically, the forward PE reached a peak of 25 in late 1999 during the tech bubble.

Concerns about Valuations and Historical Context: While acknowledging that valuations are not cheap and appear stretched, the speaker believes that significant valuation multiple contractions typically require another substantial recession scare or an actual recession. During the correction earlier in the year, the forward PE briefly dipped to 18, which is still above the typical range of 15-18 for a correction and significantly higher than the low teens or even 10 seen in a bare market.

Resilience of Valuations: The speaker argues that if the economy remains resilient, current valuation multiples can be sustained. This resilience has been demonstrated over the past three years, despite numerous anticipated recessions that never materialized.

Divergence within the Market: A notable observation is the difference in valuations between the "Magnificent 7" (forward PE over 30) and the "Impressive 493" (forward PE around 19). While the latter is not cheap, it is considered relatively more sustainable as long as the economy grows.

The "Roaring 2020s" Analogy and Tariffs: The speaker addresses the pushback against the "roaring 2020s" analogy by referencing the negative outcome of the 1920s, which ended with the Great Depression following the Smoot-Hawley Tariff in 1930. However, the current situation is different, as significant tariffs have been imposed or discussed without major retaliation or trade wars, and without a significant impact on growth or inflation in the U.S. economy.

Speculative Bubbles and Financial Conditions

Bubble After Bubble Phenomenon: The speaker expresses astonishment at the recurring speculative bubbles observed in the last five years, including ICOs, NFTs, the Metaverse, cryptocurrencies, sports betting, and zero-day options. This trend suggests increasing levels of speculation in the market.

Fed Rate Cuts and Financial Conditions: The speaker opposes Fed rate cuts, citing the low unemployment rate (4.3%) and inflation still above the 2% target (around 3%). The argument is that financial conditions are already loose, with the stock market, gold, and Bitcoin all at record highs. Lowering interest rates, in this context, is seen as an attempt to stimulate demand further, which is already robust.

Supply-Side Issues and AI's Role: The speaker identifies supply-side issues as a primary driver of current economic conditions, rather than demand-side problems. These include a decline in the foreign-born population, a halt in hiring by state and local governments for migrant-related services, and companies assessing AI for potential productivity augmentation, leading to a pause in new hiring.

Risk of a "Meltup": The combination of Fed easing, liquidity, and stimulus increases the risk of a "meltup" situation, where asset prices rise rapidly and unsustainably. The speaker expresses concern about reaching 7,700 on the S&P 500 with a 25 multiple, which could be indicative of such a scenario.

AI Hype and Oracle Deal: The current market environment is characterized by AI hype, exemplified by the Oracle deal with OpenAI. The speaker questions the realism of such valuations, given that OpenAI reportedly has no profits. This situation, along with the opening of the IPO and M&A markets, creates a self-reinforcing cycle for financial companies, which can be positive until it's not.

Federal Reserve Policy and Inflation

Reasons for Fed Rate Cut: The Federal Reserve's decision to cut the Fed funds rate by 25 basis points is attributed to perceived weakness in labor market indicators and potential political pressure. While the unemployment rate is low, initial unemployment claims had jumped prior to the decision, and subsequent data showed a sharp decline.

Downward Revisions in Jobs Data: The speaker acknowledges downward revisions in jobs data, including a significant revision of 911,000 jobs for the year ending March 2025. However, the focus remains on the overall strength of the economy and the role of productivity.

Productivity's Impact on Inflation and Wages: Productivity growth is seen as a key factor keeping inflation in check by moderating unit labor costs. It also boosts real wages and corporate profits. The speaker argues that given the strong economy and productivity, interest rates should be higher, around 4-4.5%, rather than lower.

Fed's Dual Mandate and Neutral Rate: The speaker questions the Fed's decision to ease policy when it has achieved its dual mandate of maximum employment and price stability (or close to it). The concept of a "neutral rate" is criticized as arbitrary and unmeasurable, with the speaker believing it to be around 4-4.5% rather than the Fed's estimated 3%.

Political Influence on the Fed: There is a concern that the Fed may be becoming too political, particularly in its rate cut decisions. The speaker believes the Fed should not have cut rates last year, arguing it was a mistake and potentially politically motivated to help Democrats.

Bond Market Reaction and Bond Vigilantes: The bond market has reacted negatively to the Fed's rate cuts, with bond yields rising. This is attributed to the "bond vigilantes," who exert pressure on governments to manage fiscal excesses. The Fed's reduced quantitative easing has given the bond market more influence.

Inflation Resilience and Price Levels: Inflation has proven surprisingly resilient, stalling around 3% coincident with the imposition of tariffs. While the Fed targets 2%, the speaker questions whether they are now targeting 3% or learning to live with it, prioritizing the labor market over inflation at this level. The price level itself is not expected to decrease without a significant recession, as wages have largely kept pace with price increases since the pandemic.

Durable Goods and Services Inflation: Tariffs are seen as impacting durable goods prices, causing them to rise instead of fall as they did pre-pandemic. Services inflation also remains higher than pre-pandemic levels.

Central Bank Priorities: The speaker suggests that central banks should prioritize financial stability, followed by price stability and then supporting the labor market. Fiscal policy is seen as a more appropriate tool for addressing labor market issues.

Quote on Monetary Easing Cycles: "More often than not, in the past, monetary easing cycles started with the previous tightening of monetary policy triggered a financial crisis that quickly turned into an economywide credit crunch and a recession. Easing at such times is clearly warranted. But the Fed cut the Fed funds rate by 100 basis points at the end of last year and there was no credit crunch and no recession when they did so. That makes another round of rate cuts in this cycle more likely to cause inflation to remain above the Fed's target while fueling speculative fires in the stock market."

Future Inflation Trajectory: Inflation is expected to remain around 3% for now. The speaker points to rising durable goods prices and persistent services inflation as key drivers. The Fed's continued rate cuts or inaction could erode its credibility.

Gold and the US Dollar

Bullish Stance on Gold: The speaker is bullish on gold, having become positive when it crossed $2,000. The target price was raised to $4,000 when gold crossed $3,000, and this target is expected to be reached by year-end. Projections extend to $5,000 by the end of next year and potentially $10,000 by 2029.

Drivers of Gold Prices: Several factors are driving gold prices:

• Central Bank Accumulation: Countries that are not aligned with the U.S. (e.g., China, Iran, Venezuela, North Korea) are accumulating gold as a hedge against potential freezing of dollar reserves.
• Chinese Investor Behavior: Chinese individual investors, having suffered losses in the real estate and stock markets, are turning to gold.
• Indian Demand: India has a long-standing preference for gold as jewelry and an asset class.
• Geopolitical Risks: Increased focus on geopolitical risks, such as the war in Ukraine and tensions in China and the Middle East, is driving demand for gold as a safe-haven asset.
• Central Bank "Put": The perceived willingness of some central banks to buy gold provides a floor for its price.

Gold vs. Bitcoin: The speaker draws a parallel between Bitcoin and gold, suggesting gold might be the "physical Bitcoin." However, they cater to different investor groups, with central banks being significant buyers of gold.

US Dollar Outlook: The speaker is not bearish on the US dollar, despite its recent pressure against the DXY. The DXY's heavy weighting of the Euro (52%) means the dollar-euro relationship is a primary driver. The speaker expresses skepticism about the Euro's strength given economic and political challenges in Europe.

Foreign Investment in US Securities: Contrary to expectations of capital flight from the dollar, foreigners have shown significant net purchases of U.S. equities ($600 billion) and fixed income securities (nearly $1 trillion) through July.

US as a Safe Haven: The U.S. is still considered a safe-haven destination due to its large and liquid capital markets and its rule of law, especially in the face of instability in other countries.

Canada and Global Economic Concerns

Canadian Stock Market: The Canadian stock market tends to perform well when commodity prices are surging, which is not currently the case. However, the financial sector, which is well-regulated, is doing well. Real estate is facing challenges due to overbuilding, but its immediate impact on the stock market is uncertain.

U.S.-Canada Trade Relations: Investors are learning to live with the uncertainty of trade wars and tariffs between the U.S. and Canada. Continued dialogue on trade is seen as positive, with the expectation of deals that incorporate elements from previous agreements.

Canadian Labor Market Issues: Similar to the U.S., Canada is experiencing labor market issues. The speaker highlights high unemployment rates in Canada, particularly in Ontario and Toronto, and a significant youth unemployment rate.

Global Bond Yields and Debt Crises: Concerns are raised about potential debt crises in other countries, with France, the UK, and Japan experiencing soaring bond yields. These countries are seeing bond vigilantes exert pressure on politicians to address fiscal excesses.

French and German Bond Yields: French bond yields are comparable to Italian yields. German bond yields have risen despite a lack of major inflation or debt problems, due to increased defense spending and a slowing economy, which may necessitate stimulus programs.

Technology and Future Outlook

AI as an Evolutionary Development: Artificial Intelligence (AI) is viewed as a significant evolutionary development within the digital revolution. Its ability to process data more cheaply and quickly creates a self-reinforcing cycle, driving demand for data centers, software, and hardware. This technological revolution is considered a major, structurally bullish driver of the economy.

Concerns about "Meltup" and Speculative Bubbles: The speaker's primary concern is a "meltup" scenario, similar to 1999-2000, driven by the Fed's actions and speculative fires. However, this does not necessarily have to lead to a recession; it could result in a correction or a short bear market, which would be viewed as a buying opportunity.

Resilience of the US Economy and Corporate Management: The U.S. economy and stock market have demonstrated remarkable resilience, performing well despite challenges from Washington. American companies have excelled at managing their operations effectively under tumultuous conditions.

The Role of the Workforce: The speaker emphasizes the crucial role of the everyday working men and women who contribute to the economy's success, regardless of political leadership. This collective effort is seen as a fundamental driver of positive economic outcomes.

Yardeni Research: The speaker, Ed Yardeni, promotes his research services available at yardeni.com for institutions and individuals. He also highlights yardeniquick.com, a daily insight into the relationship between the macroeconomy and financial markets.