(Note: The author of this fundamental analysis is a financial writer and portfolio manager.)
The 2017 equity market has displayed a tremendous amount of resiliency, with every minor pullback of 1 or 2 percent getting investors worried that it is the start of the next big 10 percent correction. Despite most investors' worst fears, we haven't gotten that correction. It is hard to justify at this point a substantial reason to get a 10 percent correction. The S&P 500 (SPY) rising to 2,650 is entirely reasonable, and would not even require valuation getting stretched.
Simple math tells us a 10 percent correction in the S&P 500 takes the index down to around 2,230, which is nearly 5 percent above where the S&P 500 was at the close of trading on November 7, 2016, which was election day. At that price level, the index would trade at a 2018 forward P/E ratio of just below 17, which is cheap historically.
The historical PE ratio since 1988 without the chaos of the financial crisis, the fourth quarter 2008 until fourth quarter 2009, averaged just a shade over 21.5. Even at current levels, the S&P 500 is cheap at roughly 18.5 times 2018 earnings per share estimates.
Keep in mind that corporate America had been in an earnings recession for much of 2015 and 2016, and only recovered recently. Earnings had started declining in the second half of 2014 and finally started to accelerate higher in the second half of 2016. The earnings decline led to a stagnant equity market. The market is now in the early stages of recovering.
The Case For 2,650
If the market keeps a cool head and doesn't run too hot, it is entirely plausible for the S&P 500 to run to 2,650 by year-end and still not be overvalued. At the estimated $132.68 in EPS by 2018, the S&P 500 would only be trading a shade over 19 times 2018 estimates. That is still below historic norms. If the market starts to run hot, give us further multiple expansion and approaches 20 times forward, it could start approaching a number closer to 2,650 by year-end.
In the fourth quarter of 2011, earnings stalled and so did the market, until the first quarter of 2013. Earnings growth was near-zero at that time, but the market had an aggressive Fed pumping money into the system, so the equity market rose 22 percent during that time. But from the first quarter of 2013 until the second quarter of 2014, the market increased by almost 26 percent, while EPS grew by 17.5 percent.
Since this latest earnings up-cycle began, earnings have increased by roughly 15 percent, while the S&P 500 has gained almost 18 percent. Analysts are looking for EPS to grow by 48.5 percent into 2018. (See also: S&P 500 Up 75%, Yet Millennials Are Wary of Stocks.)
Based on the current valuation of the market and projected earnings growth over the next year, it is plausible that the market is closer to the beginning of the up-cycle than toward the end, with a move to 2,650 entirely possible.
Michael Kramer is the Founder of Mott Capital Management LLC, a registered investment adviser, and the manager of the company's actively managed, long-only Thematic Growth Portfolio. Kramer typically buys and holds stocks for a duration of three to five years. Click here for Kramer's bio and his portfolio's holdings. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Upon request, the advisor will provide a list of all recommendations made during the past twelve months. Past performance is not indicative of future performance.