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S&P 6300? Is that out of the realm of possibility?

by xyonent
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Stock Market Bull E1715518661808.png

Goldman Sachs Recently, S&P raised their year-end target price to 6300 and Evercore ISI also raised their year-end target price to 6000. This is not surprising given how strong the market has been this year. Just two weeks ago, I posted this chart:

“We should see a wave of price target hikes on the S&P 500 as we approach the end of the year.”

Such bold figures may seem unrealistic, but there is fundamental evidence to support them.

Last week, I “Fundamental increase in valuation” In that article, I explained how it happened:

“There are many reasons why valuations have risen over the years. Part of the reason for the rise is economic expansion, globalization, and increasing profitability. However, since the turn of the century, changes in accounting rules, share buybacks, and the growing popularity of investing (ETFs) to the general public have also contributed to the change. Additionally, as mentioned above, massive monetary and fiscal intervention since the ‘financial crisis’ has created a seemingly ‘risk-free’ environment for equity risk.

This chart shows a clear shift in valuation.”

  1. The “median” CAPE ratio is 15.04 times earnings from 1871-1980.
  2. The long-term “median” CAPE is 16.52 times the returns (all years) from 1871 to the present.
  3. The “median” CAPE is 23.70 times earnings from 1980 to the present.

There are two important things to consider about the graph above.

  1. The increase in the median valuation is due to slowing economic growth and deflationary pressures.
  2. Rising leverage and debt have hampered economic growth and driven up prices.

So, my question is, “if” Valuations have been permanently elevated, but what will the next market mean reversion event be that will reset fundamental valuations to more attractive levels?

We answered that question by analyzing current market prices and forecast earnings to determine the shape of such valuation reversals.

At the time of writing, the S&P 500 is trading at around $5,300 (rounded down for easier calculations), with projected earnings of around $217 per share in 2024. Using the median valuation levels above, we can plot the price decline required to reverse the valuation.

  • 23.70x = 5142.90 = 3% drop
  • 16.52x = 3584.84 = 33% drop
  • 15.04x = 3263.68 = 38.5% drop

But the story “The other side” This is where multiple expansion occurs.

S&P 6300 – The other side of the story

Why did I choose the S&P 6300? Using the standard Fibonacci sequence, I identified a logical number sequence from the lows in November 2023. A 1.62% rally from these lows would put the market at roughly 6300. (6255 to be exact)But for the market to rise that far, underlying earnings will need to support continued gains.

As mentioned in my previous article, valuation contractions occur during recessions and bear markets. During these phases, market exuberance causes the market to realign with underlying fundamentals. However, before the reversal process begins, multiple expansion is underway. During this bull phase, Wall Street analysts continue to raise earnings estimates to justify price increases. Currently, we are in a multiple expansion phase, with analysts dramatically raising earnings estimates to more extreme levels. As shown, 2025 earnings estimates are at a record deviation from long-term exponential growth trends.

So how can the S&P 500 reach 6300? We can use current Wall Street projections to work backwards in the valuation process. As before, we would normally look at the market price and “Fair Value” Market valuation based on expected profits. In this case, the denominator of the valuation formula (profits) is: “Fair price” of market.

For this thought experiment, let us take S&P Global’s current end-2024 share price forecast of $216/share, while Goldman sees $6,300 at the end of this year. For Goldman’s $6,300 forecast, the valuation rises to 29 times earnings over the past year. However, we also assume a lower valuation of 27 and 25 times earnings by the end of the year if economic growth continues to slow. Furthermore, we also consider that earnings fall to $200/share if the economy starts to head towards a mild recession. However, given that Wall Street forecasts are always overly optimistic, earnings could be discounted even further. However, these parameters give us the following results:

  • $216 per share x 29 times past earnings = 6264 (Assuming economic growth continues)
  • $216 per share x 27 times past earnings = 5832 (Assume economic growth stabilizes.)
  • $216 per share x 25 times past earnings = 5,400 (Assuming economic growth will slow further)
  • $200 per share x 25 times past earnings = 5,000 (Assuming a mild economic downturn)

As before, we can use these projections to create a chart showing the range of potential outcomes over the next six months.

These outcomes are just a few assumptions. By adjusting valuations and earnings expectations, an infinite number of possibilities can be created. However, the purpose of this exercise is to establish a plausible range of market possibilities at the end of the year. As shown, the range of potential outcomes is wide from market levels as of this writing. The “no recession” bull argument implies the possibility of a recession. From 7.4% to 15%But the economy If the economy slows or falls into a mild recession, the potential declines range from -1% to -8%.

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Challenges remain

I have no idea what will happen over the next 6-18 months. As I said, the possibilities are endless. The outcome of the November election, Fed policy, and a possible recession will all influence one of those outcomes.

Our concerns about the bullish scenario are: “There is no recession” As a result, the Fed will have to reverse its tightening monetary policy. The problem with this view is that if the economy were indeed to experience a soft landing, the Fed would have no reason to reverse its balance sheet reduction or to cut interest rates significantly.

More importantly, rising asset prices continue to ease financial conditions, keeping inflation in check. “Stickiness” The result is erosion of consumer purchasing power. The bull case suggests that employment will remain strong along with rising wages, yet there is clear evidence that both are declining.

While a bullish scenario for the S&P 6300 is possible, that outcome faces a number of challenges heading into 2025, given that the market is already trading at fairly high valuations. “Soft Landing” The environment should weaken earnings and make current valuations more difficult to maintain.

Our guess is that the reality is somewhere in the middle. There is certainly a bullish scenario in which earnings fall and monetary policy shifts cause investors to pay more for the decline in earnings. But because valuations matter for long-term returns, this outcome is limited in duration.

As investors, we should expect lower valuations and prices where long-term returns are most likely, and unfortunately, we don’t want to have to fight the pain of getting there.

Regardless of which scenario unfolds in real time, there is a substantial risk of weak earnings over the next 6 to 18 months. As investors, we need to manage the risk of unexpected developments that could undermine Wall Street’s continued optimistic outlook.

At the end of the day, math is just math.

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2024/06/25

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