January 19, 2020

With earnings season quickly approaching, it is perhaps a good time to look at the S&P 500 from a valuation perspective over the longer-term. Recently we have been focusing on the market’s steady advance and ever mounting sign that the market is getting a bit overheated at current levels. However, over the longer-term, the outlook continues to suggest that the market can rise to even higher levels. Premium content – Stock Are Pushing The Boundaries – get the first two weeks for free, no harm in trying it!

First off earnings growth is expected to see a significant bump in 2020, rising by around 11% to about to $175.30 per share based on estimates from S&P Dow Jones. Then in 2021, it is forecast to grow by roughly 9% more to $191.22 per share.  

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(S&P Dow Jones)

Present Values

It leaves the index trading at roughly 19 times 2020 earnings and around 17.5 times 2021 earnings estimates. Which mostly leaves the index trading at fairly valued levels based on the historical average.

(S&P Dow Jones)

Low Rates

But again, one could easily argue that in a world where the dividend yield of the S&P 500 is basically on par with that of the 10-year Treasury, investors would likely be in a mood to take on some additional risk to generate higher returns.

The Range

I think it is fair to say in this low-interest-rate environment; the S&P 500 could see its earnings multiple move up to something closer to that of 18 or even 18.5 times one-year forward earnings. At 18 times 2021 earnings estimates, one could get a valuation of 3,441, and at 18.5, it comes to roughly 3,537. It could amount to a gain of as much as 6% from its current levels of 3,329.

Reasonable? Sure. Over the last 20 quarters, the average P/E ratio has been 17.4, with a standard deviation of 1.11, meaning that the S&P 500 could trade with a PE ratio in a range of 16.28 to 18.51, a trading range of 3,112 to 3,539. 

Of course, we know that overtime earnings estimates have a tendency to decline, and should we shave 5% off current the forecast of $191.22, we could have earnings of $181.66, reducing the range to 2,956 to 3,362.

So, in this interest rate environment, the Fed on the sideline, and the potential for an improving economy, I’d be willing to bet the upside risk in the stock market, is greater than the downside risk. But of course, pullbacks will occur and will likely happen often during the march higher.

-Mike

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