Taking numbers from Factset, a very reliable source, the S&P 500 is trading at about 17x estimated 2017 earnings. That’s based on the assumption of slightly more than 10% eps growth from the S&P components this year–a figure I think is reasonable.
This is a potential problem for stock market returns in 2017, since that PE is maybe 12% higher than average for the S&P 500 index over the recent past. And, of course, interest rates will likely be rising throughout this year and beyond.
Arguably, the elevated PE means that the sharp rally in stock markets since the Trump election has already factored into today’s prices everything positive that Mr Trump is likely to get done during the next 12 months.
That’s the safest assumption. Concluding that doesn’t imply that there’s no money to be made in stocks in 2107, however. Instead, it suggests that sector and stock selection will be the only money-making game in town.
Also–and this may simply be my inherently bullish nature taking over–that assumption may be too conservative. It seems to me an important characteristic of fundamental changes in market direction is that they’re not driven by changes in consensus earnings. Rather, the market tends to move considerably in advance of changing earnings.
We see this most often as the business cycle waxes and wanes. At the bottom (top) of the cycle, when the Fed signals that it is going to lower (raise) interest rates, there’s an immediate, significant change in market direction and tone–even though it will take many months for the new interest rate regime to play out in earnings. We can also observe this in commodity price-driven industries like oil, where stocks react sharply to changes in spot prices. Oilfield services firms are especially instructive in this regard, since their stock prices tend to react in a high-beta way to oil price changes even though the firms may have long-term, fixed-price service contracts. That’s because experienced investors realize that when an oil major simply returns a drilling rig to a service company and says it will no longer pay, there’s little that can be done …if the services firm expects to have any business during the next upturn.
It seems to me that the S&P is now anticipating a similar kind of (favorable) economic step change during the early years of a Trump administration. I see no reason to bet against this outcome. This has little to do with Mr. Trump’s obvious flaws; it’s mostly because the electorate has put power decisively into the hands of one party. If I’m correct, I’d expect the market to move sideways until we get evidence in legislation that substantial fiscal stimulus is under way. Assuming this occurs, the second half of 2017 will likely be substantially better than the consensus now expects.
Of course, one has to keep the potential for downside clearly in mind. My biggest worry: my reading of his business career is that Mr. Trump has saved himself from his substantial bet-the-farm misjudgments (think: Atlantic City casinos) mostly by throwing his partners under the bus. In the present case, that’s you and me.