A Rational View Of S&P 3,500+

April 29, 5:00 pm EST

We ended last week with a positive surprise for Q1 GDP.  Today, we had more soft inflation data.

The Fed’s favored inflation gauge, core PCE, continues to fall away from it’s target of 2%.

Here’s a look at the chart …


With a Fed meeting this week, they remain in the sweet spot.  They have trend economic growth, subdued inflation and a 10-year yield at 2.5%.  They can sit and watch. They could cut!   That’s highly unlikely, but less unlikely by the summer, if current conditions persist.

The market is pricing in about a 60% chance that we’ll see a rate cut by year-end.  It doesn’t sound so crazy, if you consider that it would underpin/if not ensure the continuation of the economic expansion — perhaps even fueling an economic boom period.

Remember, we’ve talked about the 1994-1995 parallels. In 1994, an overly aggressive Fed raised rates into a recovering, low inflation economy.  By 1995, they were cutting.  That led to a 36% rise in stocks in 1995.  And it led to 4% growth in the economy through late 2000 — 18 consecutive quarters of 4%+ growth.  Stocks tripled over the five-year period.

This, as the S&P 500 is already sitting on new record highs?  As I said earlier this year, with yields back (well) under 3%, we should see multiples on stocks expand back toward 20x in this environment.

The forward 12-month P/E on the S&P 500 is currently 16.8.  If we multiply Wall Street’s earnings estimate on the S&P 500 ($175) times a P/E of 20, we get 3,500 in the S&P 500. That’s 19% higher than current levels.

But keep in mind, the earnings estimate bar has been set low.  And already 77% of companies are beating estimates on Q1 earnings.  I suspect, we’ll see higher earnings over the next twelve months than Wall Street has estimated, AND a higher multiple paid on those earnings (i.e. an outlook for an S&P 500 > 3,500).

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