Here Comes 27% Earnings Growth. Plus, Bitcoin Goes Legit.

Model portfolios are no longer one size fits all. In fact, 85% of investors want financial advisors to deliver models customized to their individual goals, investment preferences, and tax circumstances. Discover some of the top themes driving the shift in Seizing the Next Model Moment by BlackRock. So when you think about the framework for forecasting equities, you got the economy, you have earnings, you have valuation, and you have money flow. And I think all All 4 of those are generally supportive of an equity market that's likely to move towards 4,300 at the end of this year.

Welcome to the Barron's Streetwise Podcast. I'm Jack Howe. The voice you just heard, that's David Kostin. He's the Chief U.S. Stock Strategist at Goldman Sachs. And when he says 4,300 at the end of this year, he's talking about his target for the S&P 500 index. It means he expects the U.S. stock market to rise another 9% this year, bringing its full-year return to 14%. That's not just cautiously optimistic, it's regular optimistic. David thinks the stock gains will be driven by a 27% jump in company earnings. Almost makes me want to upgrade my opinion on stocks from "yeah, I guess" to Hot diggity dog. Easy now. We heard the bear case against stocks last month when renowned money manager Jeremy Grantham told us we're in a bubble. This week, David will present the bull case for stocks. Listening in is our audio producer Meta. Hi, Meta.

Hi, Dick.

Meta, everyone's making a killing on this Bitcoin. Tell me the truth, are you in on this thing? You have Bitcoin?

I have a 0% allocation in Bitcoin.

What about Litecoin?

No, no money there.

Dogecoin?

No money.

Candy Corn Coin?

Nope.

Bitcoin?

No, again.

I tried to circle back and catch you on that. All right, I'm going to take your word for it for now. We have to congratulate the Bitcoin bulls. The price of Bitcoin went over $50,000 this past week, which is incredible.

Big day for Bitcoin. That new record brings the cryptocurrency's gains in the past 6 weeks to about 70%.

A year ago on Valentine's Day, Bitcoin sold for around $10,000.

Bitcoin surpassing $10,000 this week, highest price since September 2019, and the cryptocurrency is up more than 40% so far this year.

And I wrote in Barron's magazine that I had 2 questions. The first was why it wasn't selling for twice that much, and the second was why it wasn't worth zero. Bitcoin doesn't have any earnings or dividends or assets to value like stocks. It doesn't have ornamental or industrial value like gold, and it's not associated with any interest rates like currencies. It's easy to guess where it's headed, but it's difficult to say what it's worth based on fundamental measures of value. To me at the time, the case for Bitcoin moving higher rested on two things. The first is that Bitcoins are created by people who devote vast computing power to a process called mining. And the reward for Bitcoin mining, it's designed to get cut in half every 4 years, give or take. In the past, that has tended to coincide with a price spike for Bitcoin. There was another cut in the Bitcoin mining reward coming up, and I thought maybe the price will spike again, but it didn't really. The reward got cut last May, but Bitcoin still sold for $10,000 and change as recently as last October. I gave another reason a year ago that Bitcoin might rise, and I guess you could say it was pretty dismissive. You might have heard market strategists talk about investors making a flight to safety or a flight to quality during times of market stress. I wrote that conditions looked perfect for a flight to nonsense. Interest rates, of course, are absurdly low. This past week I received a bank pitch in the mail that said, "Safety and growth for your family." It was for what was described as a high-yield savings account. The interest rate? It was 0.5%. How is that a high yield? Well, the pitch explained that 0.5% is 10 times the national average. When interest rates are left that low for years, You don't miss out on much interest parking money in shares of fast-growing companies, ones that don't necessarily earn much money today, and investors pile in. Sometimes it's difficult to tell how much of a stock's rise is due to company success and how much is due to market froth. For example, there's a company called Virgin Galactic that's working on tourist flights to space. I mean, there's a debate about whether they're actually going to space, They're going to the outer limits of the Earth's atmosphere where passengers will briefly experience the weightless feeling of space. Some people say it's not actually space. Think of that movie 2001: A Space Odyssey. This is 2021, a really, really high but maybe not quite space odyssey. Anyhow, the company hopes to launch service late this year and it isn't expected to generate meaningful earnings for years. But its shares have more than doubled so far this year. Is that because space tourism suddenly looks twice as promising? Or is it because investors have simply decided to pour more money into space? It's difficult to say. Here's maybe a clearer example. We mentioned a cryptocurrency called Dogecoin a few weeks ago. It was started as a parody of Bitcoin. Doge is an internet meme involving the image of a dog and captions with quirky grammar representing the dog's inner monologue. Here's what's not a parody. Dogecoin sold for less than half a penny at the end of last year. It went over 8 cents earlier this month, and more recently it was still over 5 cents. Now, 5 cents might not sound like a lot of money, but if you're selling something for 5 cents that cost you less than half a penny at the end of last year, you're making more than 10 times your money in under 2 months. I guess that's what I meant by flight to nonsense. And no offense to any Doge tycoons out there, I wish you the very best. But I better adjust the way I talk about Bitcoin. On this podcast, we've heard from savvy investors like Mohamed El-Erian, chief economic advisor to Allianz, who told us he owns some Bitcoin. Earlier this month, Tesla announced it had put $1.5 billion of its cash reserves in Bitcoin. And that it plans to accept Bitcoin as payment for its cars. Visa, MasterCard, Bank of New York Mellon, and other big financial institutions have recently announced plans for more fully participating in the Bitcoin ecosystem. Whether Bitcoin's rise is a sign of speculative excess, time will tell, but clearly Bitcoin has reached a critical mass where I should probably stop dismissing it as nonsense. I have a friend, he's not a Wall Street practitioner, just a private investor, and his Bitcoin holdings recently hit $1 million in value. He sold a little bit. He used to tell me, "I don't know how legit it is, but I think there'll be more demand than supply and the price will go up." Now he says, "Look how many pros are getting involved. It's starting to look more legit." And he's right. I'm not buying Bitcoin, but it'll be fascinating to see where it goes next. If there's nothing to say it's worth $50,000, that means there's nothing to say it's not worth more. The market value of Bitcoin is closing in on a trillion dollars. That's a large enough number to have macroeconomic implications. Recently, policymakers in the US were talking about a $1.5 trillion stimulus package with a goal of helping people, of course, but also getting more money circulating in the economy. Meanwhile, there's nearly $1 trillion parked in Bitcoin, which barely existed a decade ago. We've never seen anything like this, and I'm riveted. To the Bitcoin bulls, best of luck. Would have been nice to buy Bitcoin a year ago, but not as nice as it would have been to buy Dogecoin in December. Meta, why didn't I put everything in Dogecoin in December? Tell me the truth, am I just bad at analyzing parody cryptocurrencies that are based on internet memes, you can tell me. It won't hurt my feelings.

I can't talk right now. I'm counting my Dogecoin.

I knew it. I knew it. This would really shake my confidence if it weren't for the fact that the regular old stock market is doing so darn well. And to learn more about whether it might keep doing well, I reached out recently to a top Wall Street strategist. Hi, David.

Hello.

It's Jack Howe from Barron's. How are you?

Very good. I'm doing great. We each have a map of New York behind us, a nice plant. So this is good.

We're ready to go. David Kostin is the chief U.S. equity strategist at Goldman Sachs. In recent weeks, he's been studying U.S. earnings results, and they've been remarkable. Just before results started rolling in for the fourth quarter of last year, analysts predicted that earnings would come in down 11% year over year. And that makes sense. In fact, it's upbeat, all things considered. We're in a pandemic. Businesses like restaurants, movie theaters, and theme parks are operating at a fraction of full capacity. Malls are hurting. During the fourth quarter of 2019, None of those things were true. So an 11% decline would have been understandable. Now the results are mostly in, and instead of an 11% decline, fourth quarter earnings are trending toward a 2% increase. That means companies have grown even more profitable during the pandemic than they were before the pandemic. I asked David, how is it that even though life still feels locked down, we're reaching record earnings?

There's definitely been a tech contribution that's very significant. If you think about it for just a minute, the largest 5 companies or 5 of the big stocks that everyone focused on last year had revenue growth in 2020 of 18%, positive 18%. In contrast, the other 495 stocks in the S&P 500 actually had sales declines of around 5%.

Okay, so even though restaurants and malls are hurting, a handful of internet giants like Apple and Microsoft and Amazon are doing better than ever. And since the S&P 500 index weights companies by stock market value, those giants are pulling index earnings higher, even though the typical company in the index has seen earnings fall a bit. Still, the earnings declines most companies are reporting don't sound so bad. So what else is going on? Here's David.

There's been a recovery in margins. Companies have been judicious, whether that's hiring back individuals or much less T&E, right? Business people are not traveling, so there's no hotel expenses, there's no airline costs, there's lower operating expenses for some businesses.

When David says T&E, he means travel and expenses. And of course, he's right. Right now I have zero T and very little E. Up until a year ago, I was spending company money on flights, hotels, meals, and more to visit with company chiefs or talk at conferences, and now I just do Zoom calls. Personally, I expect to go back to hitting the road now and then by the end of summer when vaccinations are widespread, but having seen how much I can do from home, I wonder if my travel spending will bounce only part of the way back. Assuming I'm not alone, that means there's a lot more reopening to be done, which is good for the economy, but also that many companies will hold on to their lower expenses. That's not good if you're a worker who depends on that spending, but it does boost profit margins. Here's David on the virus, the vaccines, and the potential pace of reopening, plus one other tailwind.

Something in the vicinity of 80 to 100 million Americans were already infected, if you will, and something on the order of 40 million Americans have been vaccinated now. So you're looking at something in the vicinity of around 35% of the country has some of those antibodies. And I'm not an epidemiological expert by any means, but that's the data we're anticipating. And the Goldman Sachs economics team is anticipating that about half of the country will have been vaccinated by the middle of the year. So that vaccine, I think, is a big, big, big tailwind. And the second is we're looking for like $1.5 trillion approximately of fiscal stimulus. So I think those two things, Jack, are very much tailwinds for activity in 2021.

I asked David for some summer vacation analysis for strictly professional reasons. My family missed our yearly theme park trip last year, and I'm thinking of booking a humdinger of a trip for late August on the assumption that we'll all have vaccines by then. Now, usually the parks aren't too packed at that time of year, but What if everyone is doing a humdinger theme park trip this year to make up for missing out last year? The parks might be packed. And more broadly, does that mean pent-up demand could lead to a surge in economic growth and more upside earnings surprises pulling stocks higher? Also, if I go to the theme park, should I choose the hotel that looks like a tiki village? And is the luau dinner show a good idea? Here's David on most of those things?

I would say both anecdotally as well as sort of part of the modeling is we are expecting there's a pent-up demand and desire for people to socialize, whether that's travel, whether it's seeing relatives they haven't seen in a year in some cases. We have great optimism for the latter part of this year. I think you're really going to see the acceleration in the second quarter, partly because of the vaccine, but also because of the fiscal stimulus that we're anticipating.

What about all the bubble talk I've been hearing? Does it mean we're in a bubble, or does the fact that so many people are talking about a bubble mean we're aware enough of the dangers of a bubble to not be in one yet?

On an absolute basis, there is no question that the US equity market is extremely highly valued. You can look at the market cap to GDP ratio, P/E multiples, enterprise value to sales, enterprise value to EBITDA. Price-to-book, any one of those metrics are going to tell you the US equity market is somewhere between the 90th and the 100th percent of the historical valuation versus history. So on an absolute basis, Jack, that is definitely the Exhibit A for bubble valuations. Exhibit B, of course, another side of it is relative to the super-low interest rate environment, and whether that is investment grade, high yield, treasuries, other metrics of a measure of a cost of borrowing, equities actually look reasonably attractive relative to history. It's like maybe the 30th or the 40th percentile, so a little bit below average in terms of valuation, which means there's some upside.

David says part of the discussion about the recent run-up in stock prices should include the recent run-up in earnings estimates too, because higher earnings will make stocks look less expensive.

The positive earnings revision has been across the market, and in fact, we, uh, Goldman Sachs, we raised our earnings forecast for 2021 to around $181 earnings per share for this year, 2021. And you have to put that in context with where we were in 2019, pre-pandemic. So pre-pandemic, you're $165. Today, in our forecast, $181. That's about a 10% increase. We're expecting that earnings this year will be 10% higher than pre-pandemic.

If David's right, earnings will grow 27% this year, almost twice as fast as he expects share prices to rise. The S&P 500 would end this year at about 23 times this year's earnings, which is expensive, but it's less expensive relative to earnings than it was at the end of 2020. David says he's watching 3 main sources of money flowing into the market. The first is $5 trillion in money market funds, a trillion more than a year ago, all earning next to nothing, of course. The second is foreign investors who tend to buy U.S. stocks when the dollar is weak, and Goldman is forecasting a relatively weak dollar this year. The third is companies buying and retiring their own shares with the goal of making remaining shares more valuable. That's called repurchasing stock, and repurchases jumped a lot after the 2017 Trump tax cuts, then plunged at the start of the pandemic. And now David expects repurchases to rebound. I asked David, does investing in stocks seem riskier than it used to be? I mean, if the case for stocks now depends on low interest rates, what happens when the Federal Reserve raises rates? And even before then, you might have heard people talking about the yield curve steepening. That's a fancy way of saying that longer-term bond yields are rising, which can be a sign that more inflation is expected, which could be a precursor to the Fed one day having to raise rates to keep inflation from getting too high. Is David worried about any of that? Not for now.

Our expectation is that the Fed will be on hold until 2024. So, Jack, you're looking at multiple years, plural, years of interest rates basically pinned around zero. Yes, there's concern about inflation. Fed kind of wants to get that inflation up. So you've got yield curve steepening a bit. But 10-year Treasury yields now around 1.2%, maybe rising towards 1.5%, perhaps 1.75% over the next year or two. It's increasing, but not a lot. That's basically the argument, or the one of the supporting arguments, valuation for equities.

David's analysts at Goldman recently ran a screen for the types of stocks that investors should favor now. They look for companies whose sales tend to respond quickly when consumer spending picks up and which are expected to earn more this year than in 2019 before the pandemic, and whose shares don't look too expensive relative to earnings. They include companies like the home builder Toll Brothers, the toolmaker Snap-on, Charles Schwab, the industrial conglomerate 3M, and Facebook. Lastly, I asked David about Bitcoin. He says he's watching with interest how central banks and financial companies and regulators and futures markets respond. I asked him the same question I asked Meta. Are you in on this too?

I do not own any Bitcoin. I have many, many, many colleagues both at the firm and elsewhere who do own Bitcoin. So I understand some of the arguments that they put forward. Some of them are concerned about the fiat currency argument that they worried about inflation, the debasement of the currency. So they're choosing to own Bitcoin as what they perceive as a hedge against deterioration in the dollar. That's not my view, but that is the argument that is often put forward. I have difficulty saying it's a stable asset given the fluctuations in the valuation of Bitcoin. So I'm not of the view that it's a— you can't really call it a stable asset. The observed reality is it's not a stable asset.

Thank you, David, for talking it over with me, and thank all of you for listening. Meta Lutzoff is our producer. You can reach her at cryptobazillions@mad dogezkills.net. Meta skills there is with a Z?

That's right.

Yeah. Subscribe to the podcast on Apple Podcasts, Spotify, or wherever you listen to podcasts. And if you listen on Apple, write us a review. If you want to find out about new stories and new podcast episodes, you can follow me on Twitter. That's @jackhouggh. See you next week.

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