The Simple Math For Another Big Year Ahead For Stocks

December 28, 12:00 pm EST

While the President’s pro-growth plan had some wins this year, it was a slow start.

Going after healthcare first was a mistake.  Fortunately, a pivot was made, and we now have a big tax bill delivered. And we have what will likely exceed a couple hundred billion dollars in government spending on hurricane/natural disaster aid underway (the early stages of a big government spending/ infrastructure package).

Last year this time, I predicted that Trump’s corporate tax cut would cause stocks to rise 39%.  That’s a big number, that’s only been done a handful of times since the 1920s. We got a little better than half way there.

But, here’s the good news: We got there on earnings growth, ultra-low rates and an improving economy.  All of that still stands for next year, PLUS we will have the addition of an aggressive tax cut that will be live day one of 2018.

With that, my analysis from last year still stands!  Let’s walk through it (yet) again.

S&P 500 earnings grew by 10% this year.  S&P 500 earnings are expected to grow at about the same rate next year.  And that’s before the impact of a huge cut in the corporate tax rate.  The corporate tax rate now goes from 35% to 21% – and for every percentage point cut in that rate, we should expect it to add at least a dollar to S&P 500 earnings.

With that, the forecast on S&P 500 earnings for next year is $144. If we add $14 to that (for 14 percentage points in the corporate tax rate) we get $158. That would value stocks on next year’s earnings, at today’s closing price on the S&P 500, at just 17 times earnings (just a touch higher than the long-term average). BUT, the Fed has told us that rates will continue to be ultra-low next year (relative to history).  When we look back at ultra–low interest rate periods, the valuation on stocks runs higher than average—usually north of 20 times earnings.

If we take the corporate tax cut driven earnings of $158 and multiply it times 20, we get 3,160 on the S&P 500. That’s 18% higher than current levels. This analysis doesn’t incorporate the impact of a potentially hotter than expected economy next year (thanks to the many other areas of fiscal stimulus).  So, as we’ve discussed throughout the year, the backdrop continues to get better and better for stocks.

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