Can the S&P 500 Reach 2,000 Next Year?

How’s that for an eye-catching title?

But seriously, let’s take a look. Below is a chart of the S&P 500 along with its earnings. The index is the black line and it follows the left scale. The earnings is the yellow line and it follows the right scale.

The two lines are scaled at a ratio of 16-to-1 so whenever the lines cross, the market’s P/E Ratio is exactly 16. The reason I use 16 is because that’s been the market’s long-term earnings multiple.

You’ll notice that going by this metric, the stock market is still undervalued. At the October 2011 low, the S&P 500 dropped to its lowest P/E Ratio is 23 years.

The future part of the yellow line is Wall Street’s consensus estimate as provided by S&P. Let’s look at these numbers: The S&P 500 earned $96.42 in 2011. Wall Street currently expects $105.01 for this year and $119.13 for 2013. If we take a standard earnings multiple of 16, that would give us 1,906.08 on the S&P 500 by the end of next year. That would be a nice 39% run in less than 21 months.

The problem I have isn’t with the earnings multiples, but I think the earnings projections are, for now, way too optimistic. It’s certainly possible that we could see 8.9% earnings growth this year followed by another 13.4% next year, but that seems like a big stretch.

Corporate profit margins have gone about as far as they can go. Companies can no longer cut their way to prosperity; plus they have little power to raise prices. This is why the employment reports are so crucial. Companies need more bodies coming in the door.

Wall Street’s consensus assumes a major re-acceleration in earnings growth later this year (note the bend upwards in the yellow line once it hits $100). I just don’t see where that comes from. The most likely scenario is that the earnings line begins to flatten out around $100 to $105. That’s still a good deal for stocks but I think these earnings forecasts need to come back down to reality.

Posted by on March 12th, 2012 at 10:14 am

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.