Yesterday’s rally in the Standard & Poor’s 500, which pushed the index back over 3,000, sent the forward price to earnings ratio–that is the PE based on projected earnings per share for the stocks in the index–to 23.36. That’s the highest level for the forward PE since 2002.
Which would be worrying enough for traders and investors betting that stock prices will continue to move higher from here. But with earnings on the S&P 500 stocks projected to fall through 2020, the market believes that either analysts will soon begin to raise their estimates for corporate earnings or that investors are willing to look past 2020 and all the way to 2021, when Wall Street is projecting that earnings growth will resume with rocket-like speed.
Right now the Wall Street earnings consensus is that earnings on the S&P 500 will fall 22.8% in 2020 from 2019. Year over year the decline in earnings will be 14.6% in the first quarter of 2020, a 42.8% year over year decline in the second quarter, a 24.7% year over year decline in the third quarter (as the economy begins to recover and earnings begin their own improvement) and a 13% year over year decline in the fourth quarter.
For 2021, Wall Street is currently projecting a 30.4% year over year gain in earnings from the levels of 2020.
Before you get too excited about that year over year gain in earnings in 2021, notice that the projected growth in 2021 takes S&P 500 earnings only to $164.04. That not all that much above the $162.97 earnings per share for the companies in the S&P 500 in 2019. In other words from current price levels, investors and traders are looking for the market to move higher on a return to the earnings levels the supported stock above 3,000 at their 2020 high.
With the index closing in on its all time record high from February 2020, it’s hard to see how earnings alone can drive the current market much higher.
To justify these price levels you’ve got to pull 0% interest rates from the Federal Reserve, odds of more stimulus from Washington, or other “magic beans” into the discussion.
I think the market will move higher from here in the near term (June, probably, part of July maybe) on current optimism about the re-opening recovery, belief in more stimulus, and hope for an early vaccine, but I don’t see the fundamental underpinnings for higher long-term stock prices here.
In other words, the market can climb higher but it gets much riskier from here.
