What if the S&P 500 Moves up 27%?

I hope that our post on Monday gave you some optimism about the future (12-month) potential for the stock market.  But I'm guessing that in today's environment, you scoffed and did not really believe what I suggested was possible.  So today, let's see if that 27% gain would be outlandish and something that is possible.

If you look at the expected earnings of the S&P 500 in the chart below, you see that as of today, those earnings expected for the next one year are projected to be $107.04.  Yesterday, the S&P 500 closed at about 1308, so that means that today the S&P 500 has a P/E ratio based on forward earnings of 12.2.  What if the S&P 500 moved up by that 27% target we discussed for the Dow on Monday?  If that happened today, it would only push the P/E ratio up to 15.5.

Click the image above to view a larger chart.

The facts are that by this time next year, those earnings will not be $107.04, but should increase by another 8% - 10%.  In 2010 earnings moved up 46.6% year-over-year (much more than estimated in the prior year), and in 2011 earnings moved up 13.9% year-over-year (again, much more than estimated in the prior year).  For 2012 earnings are being estimated to increase by 9.9%, and like most past years, that should prove to be very cautious.  Furthermore, we have learned from past cycles that earnings estimates are usually too high when optimism is extreme, and too low when pessimism is overwhelming.  So, we believe the "normalized" estimates (the red line in the chart above), based on past oscillations, should produce earnings in the next 12 months of $108.67 versus the current estimate of $107.04.

So...what if the S&P 500 moves up by 27% (1661) in the next 12 months?  We've put that "X" on the chart below, and as you can see, it doesn't look nearly as dramatic as our statement that the "Dow will move to 16,000" in the next one year seems when first observed. 

Click on the image above to view a larger chart.

Now, that doesn't look that dramatic, does it?

Don Hays

If you are a subscriber to HaysAdvisory.com, click here to read Monday's report.  If you would like to learn more about the research and commentary offered by Hays Advisory, click here.

Please see important disclosures at the bottom of this page.