By The S&P 500 has been on a remarkable rise, fueling hopes that it may soon reach its all-time high of 4796.56 by year-end. Despite some concerns of a potential correction, experts believe that hitting this high-water mark remains within reach.
Currently trading near 4570, it’s undeniable that the index appears expensive. With the S&P 500 now valued at over 19 times the aggregate earnings per share projected for its component companies in the next year, compared to around 15 times when the index initiated its 27% rally from the October low.
This high multiple is particularly notable considering the prevailing interest rates. Higher rates tend to diminish the present value of future profits. Consequently, the market becomes vulnerable to potential setbacks should anything go wrong.
However, the same logic that propelled the market rally thus far could continue to drive further gains. The market has interpreted the declining inflation rate as a signal that the Federal Reserve will halt interest rate hikes aimed at curbing price growth and restraining demand for goods and services. Should this assumption hold true, the negative effects of higher rates might dissipate, allowing for sustained earnings growth.
Another factor that could contribute to increased profits is the rise of artificial intelligence, particularly within Big Tech companies that dominate the market. Analysts have accordingly revised their profit projections upward, anticipating ongoing earnings growth for years to come.
Simultaneously, there might be a possibility of declining rates. Currently, the two-year Treasury yield stands just below 4.8%. While not reaching the decade-high of 5%, it remains uncertain if it will climb significantly higher. In fact, should investors begin pricing in the likelihood of rate cuts, it could lead to a drop in yields across the board, including the 10-year yield which currently sits around 3.75%.
With all these factors in play, dreams of the S&P 500 reaching new heights seem increasingly plausible. While caution is advised, the potential for growth remains promising.
Expectations for Average Annual Inflation
According to data from the St. Louis Fed, expectations for average annual inflation over the next decade stand at about 2.2%. This implies that investors holding debt are well compensated for inflationary effects. In fact, any investments in bonds could cause prices to rise and yields to decline.
Implications for the S&P 500
If the 10-year yield drops to around 3%, this could potentially lead to the S&P 500 trading at a higher multiple, likely in the mid-to-high teens range. The last time the 10-year yield reached such low levels was in late August, during which the S&P 500 traded just under 18 times forward EPS. Although slightly lower than the current multiple, this shift could still propel the index higher.
Boosting Economic Growth
Lower interest rates would have a positive impact on the economy, as well as corporate profits. Decreased Treasury yields would also contribute to reduced rates on various forms of debt, ranging from mortgages and auto loans to credit cards and corporate bonds. Ultimately, this would enable individuals to spend more while providing companies with greater borrowing and investment opportunities, thereby boosting overall economic activity.
Potential for Higher Earnings
The impact of lower rates and increased economic activity on earnings could result in higher-than-expected profits. According to FactSet, analysts predict an aggregate EPS of approximately $244 for S&P 500 companies in 2024. However, recent data from Evercore reveals that companies reporting their results as of Tuesday morning beat second-quarter estimates by approximately 8%.
If this positive trend were to continue into next year, the forecasted aggregate EPS could rise to around $263.50. Consequently, if the index were to trade at a multiple of 18.2 times, it could reach a record high.
Potential Market Momentum
While these projections may seem overly optimistic, there is rationale behind them. Even if earnings forecasts fall short of reaching the stated levels, the market could still become excited about the upward trajectory of profits. This momentum could then take over, driving the earnings multiple even higher. Societe Générale’s momentum indicator suggests that equity momentum mania could further intensify.
Based on their analysis, Societe Générale’s strategists forecast the S&P 500 to reach 4750 this year. If interest rates and earnings continue to move in the right direction, the sky could be the limit for the market’s potential.
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