The bull market in the U.S. stock market recently completed its fifth year. Since March 2009, the S&P 500 gained 1,200 points or 180%.
“Three drivers of the rally: A profit rebound (59% of rally), a P/E multiple expansion (25%), and a change in expected EPS growth (16%),” noted Goldman Sachs’ David Kostin.
Now, everyone want to know if this rally can continue.
“In order for S&P 500 to climb higher, (a) the level of profits, (b) the expected forward earnings growth rate, and/or (c) the P/E multiple must change,” said Kostin. “Given the high starting point of all three metrics, it is hard to identify any one of these that will climb significantly during the coming year.”
Kostin discussed each of these three drivers. We paraphrase here:
- Profits: Goldman expects S&P 500 EPS to rise by 8% to $US116 in 2014 and 8% to $US125 in 2015. “However, the polar vortex and associated weak economic data has translated into negative sales and earnings revisions for nearly every sector during the past one and three month time frames.” Kostin also noted that managements have been “struggling to maintain current margins,” which are at record highs.
- Earnings Growth: “A potential driver of higher profits would be faster economic growth.” Goldman estimates GDP will grow by 2.7% this year. “We estimate every 100 bp shift in GDP growth translates into $US5 in EPS. In contrast, a 50 bp shift in margins has the same $US5 per share impact on EPS.” Kostin does not see EPS growth accelerating given how sharply EPS has risen since 2009 lows.
- Valuation: Valuation has been the biggest driver of stock prices, and Goldman has previously warned that there isn’t much more room for valuations to expand. “[E]quities are expensive on almost every valuation metric we use. S&P 500 currently trades at 15.6x forward expected earnings, a multiple we would characterise as the high side of a range of fair value. However, the median S&P 500 stock trades at 16.7x forward earnings, a multiple that is extremely high by historical standards. The median stock has traded at a higher multiple than today only 9% of the time since 1976.”
So, there’s not much enthusiasm here.
Kostin has a 1,900 year-end target for the S&P 500, which reflects a modest 3% gain from current levels.