The rapid recovery on Wall Street has lifted market valuations into ultra-rich territory. The S&P 500 now trades at 22.5 times projected earnings, according to Refinitiv, the most expensive valuation since October 2000 during the bursting of the dot-com bubble.

Some experts are warning this euphoria could set the stage for a major setback in the stock market given the steep challenges that still exist.

Even Goldman Sachs, which is bullish on stocks in the long run, is warning clients to brace for a bumpy ride this summer. The investment bank expects the S&P 500 will plunge back to 2,400 over the next three months, representing a potential decline of 18%.

“Concerns exist that we believe, and our client discussions confirm, investors are dismissing,” David Kostin, chief US equity strategist at Goldman Sachs, wrote in a recent note to clients.

He cited a laundry list of major risks that investors have largely shrugged off this spring, including rising tensions between the United States and China and “stretched” market valuations.

The biggest risk, of course, is the virus itself. Goldman Sachs noted coronavirus infection rates outside New York are growing and infections could “accelerate” as states relax shelter-in-place rules.

Dr. Anthony Fauci, the nation’s top infectious disease expert, said Tuesday that the “consequences could be really serious” if states reopen ahead of the guidelines issued by the White House.

Goldman still expects the S&P 500 will finish the year at 3,000 as the economy rebounds.

‘Carpet-bomb’ markets with cash

Though the run-up seems counter to dour headlines, there are good reasons for the market to have rebounded from the crisis lows.

Investors are relieved the pace of infections has slowed enough that some states, including Texas and Georgia, are beginning to slowly reopen their economies.

They’re also enthusiastic about the federal government’s record-setting stimulus package that provided direct cash payments to Americans, bailouts for airlines and forgivable loans for small businesses. More stimulus is likely on the way.

Meanwhile the Federal Reserve not only slashed interest rates to zero but also promised to buy an unlimited amount of bonds and rolled out a series of emergency lending programs for companies. The Fed is even, for the first time, directing the purchase of corporate bonds including junk bonds. A vehicle run by the US central bank began buying corporate bond ETFs on Tuesday.

“The Fed gave up on bazookas, skipped helicopters and went straight for B-52 Stratofortress Bombers to carpet-bomb the financial markets with cash,” Ed Yardeni, president of Yardeni Research, wrote in a note to clients last week. “The immediate reaction of the financial markets was: ‘It’s raining money! Hallelujah! It’s raining money!'”

And the more recent context is important: Though the S&P 500 is up 4% from a year ago, it remains down 9% on the year.

Main Street vs. Wall Street

Still, the magnitude of the rebound on Wall Street has raised eyebrows given the extreme pain on Main Street.

The US unemployment rate spiked to 14.7% in April, the highest since the Great Depression.

“There’s been a disconnect between the stock market and the real economy for years. In the wake of the pandemic, it’s become much more profound,” said Joe Brusuelas, chief economist at RSM.

Part of that chasm is because the S&P 500 is not really a reflection of the real economy. Its components, which include Microsoft (MSFT), Apple (AAPL) and Chevron (CVX), are industry leaders that generally have the financial resources to ride out the storm. Some of them, like Amazon (AMZN), are even benefiting from the disruption caused by the crisis.

But as part of its warning about what lies ahead, Goldman Sachs (also an S&P 500 stock) said restarting the economy will not be simple, especially if a second wave of infections emerges.

Buybacks and dividends are shrinking fast

Among those hit hard by the crisis are big banks including JPMorgan Chase (JPM), Bank of America (BAC)and Wells Fargo (WFC), which have set aside billions of dollars for bad loans.

And that’s just the beginning. Goldman Sachs expects banks will be forced to set aside $115 billion in loan loss provisions over the next four quarters.

Another issue is that Corporate America will have much less money to return to shareholders. Already, more than 40 S&P 500 stocks have suspended or slashed dividends this year, Goldman Sachs said, adding that dividends are expected to shrink by 23% this year.

Buybacks could take an even bigger hit, plunging by 50% in 2020.

“Investors should be concerned because buybacks have been the only source of net demand for shares in the past decade,” Goldman’s Kostin wrote.

Corporate tax hikes and tariff threats

Rounding out the uncertainity is the volatile political backdrop.

Polls suggest the race between President Donald Trump and presumptive Democratic nominee Joe Biden will be close.

If Biden wins and Democrats take control of the US Senate, Trump’s corporate tax cuts could be unraveled. The tax overhaul, enacted in late 2017, sent corporate profits booming and set off a bonanza of share buybacks.

Goldman Sachs cautioned that reversing the tax cuts could cause S&P 500 per-share earnings to shrink by $19 and lift “already stretched” valuations by around 15%.

The geopolitical situation has also become more precarious as Trump has threatened to hit China with retaliatory sanctions for its initial coronavirus response. That could cause the US-China trade deal reached late last year to implode — resulting in higher tariffs and increased uncertainty at the worst possible time.

“Tensions in the US-China relationship…are trending negatively and are likely to see a return to confrontation later this year,” Ed Mills, Washington policy analyst at Raymond James, wrote in a note to clients Tuesday. “We believe the threat may be underappreciated by the market.”

Add that to the list.

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