Stock market analysts grapple with the task of foreseeing future stock market levels. Drawing from personal experience, I know the challenges of prediction. There are so many factors. What to include and what to leave out?
Using the Donald Rumsfeld approach we could break down the "known" and "unknown" factors
There will be multiple important national elections in 2024 (but who will win and to what effect?)
The U.S. economy currently has strong GDP growth and a levelling out of the rate of inflation (might inflation prove sticky in the 3% to 4% range)
There are two major ongoing wars (will we see a resolution, increase or reduction in hostilities in 2024)
What are the unknown factors that could influence market valuations? (further breakthroughs in the pace of AI advancements....a new global conflict zone....better than expected news on inflation?)
Why is it important to have a view of the economic future
I think it's valuable to think about future stock index valuations. It allows one to combine the risk/reward of owning a stock portfolio with your holdings of cash and fixed income. Investors should consider..."am I being sufficiently rewarded for owning equities, when my cash reserves earn 5% interest".
First, step back in time.......
March 2020. It was the early days of COVID, the status quo was upended. Stock markets had been trading nicely higher and earnings were solid. Then the bottom (temporarily) fell out.
The table below reflects the S&P 500 earnings in March 2020 and the price earnings multiple at the time (the Price/ Earnings multiple for the S&P 500 index is calculated by taking the individual earnings estimate for each of the 500 companies, and then summing the weighted earnings per share). With 2020 S&P 500 earnings at $116, this index was trading at a lofty P/E of 29
Earnings increased 104% over four years, using the Goldman forecast for fiscal 2024 (January 6, 2024 / Bloomberg). The Index level increased by 51%.... analysts sensibly note that the relationship between earnings and valuation works quite well over long periods but is terrible over shorter periods in predictive ability.
Despite today's concerned commentary on index valuations, the trend over the past four years has been to lower P/E multiples. A P/E of 22 for the year 2024 does not imply an inexpensive market, but the reality is that the current investment climate has become more comfortable with this valuation level.
What might we expect over the next one to two years? Rather than attempt to make a specific prediction of future index levels, I think a range of outcomes is more meaningful. Then I can be guided as to the risk/reward of owning this equity index
The table below indicates several possible outcomes if "known" factors remain positive and "unknown" events are neutral in their influence.
These potential valuation levels are simplistic in that we are combining estimated earnings with four potential multiples. Perhaps there is a recession and earnings fall or investors collectively decide that the market should trade at a lower multiple of earnings.
Despite these unknowns, potential increases in the S&P 500 index look attractive in my view. 2024 / 2025 could provide returns that justify the risk to my capital.
Stock and bond markets are easy to write about and difficult to forecast. I still prefer a balanced approach that requires less predictive ability. I can live with drawdowns in equity and bond bear markets as I have a sense of the magnitude, based on previous bear markets. Cash reserves can be used to rebalance into debt or equity, that is on sale, to maintain my balanced approach.
regards, Tim
Tim Morton, CFA is a retired portfolio manager with 45 years of experience working with private clients. For the past two years, the editor of mortonir.com and a contributor to Barron's. My comments are not to be taken as investment recommendations. They are purely for discussion purposes. Please see your advisor for investment advice.