The S&P 500 Can Rise 7% in the Next Year. Earnings Will Have to Keep Surging.

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Charging Bull statue near the New York Stock Exchange in New York.

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Michael Nagle/Businesshala

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Strategists at Jefferies say the S&P 500 could gain 7% in the next year or so. The key factor behind that forecast is—yet—higher-than-expected earnings.

Strategists at Jefferies published a year-end 2022 target of 5,000 for the broader market benchmark. This represents a roughly 7% gain from the index’s current levels — a view lower than the firm’s expectation that total earnings per share for companies in the S&P 500 will fall to $233 in 2022. The baseline view among analysts tracked by FactSet is that the figure would be $220.

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If it does, this outperformance would mark a continuation of a trend that has benefited investors in the recent past. In the third quarter, S&P 500 EPS was about 10% higher than analysts’ estimates. While this was less than the more than 20% beating seen in previous quarters, it shows that Wall Street is underestimating the ability of companies to make profits. Analysts are known to make conservative estimates, especially when demand picks up, as was seen in the post-lockdown era.

One element behind Jefferies’ bullish profit forecast is that the economy is still growing at a relatively fast pace. According to FactSet, economists are looking for more than 5% growth in US GDP in 2022. While that will be slower than the growth seen this year, it will still be better than the sub-3% expansion seen in recent years before the pandemic.

Data from Jefferies shows that historically GDP growth of 5% correlates with income growth in the mid single digits in percentage terms in the double digits. The math checks out: That would add 12% to bring total S&P 500 EPS to $233 Jefferies forecast for 2022.

The total EPS of $233 for 2022 that the firm anticipates won’t necessarily shock the analyst community. That total would be about 6% higher than analyst estimates, and according to 2016 data from Credit Suisse, companies often beat earnings expectations by about 6%.

That’s all good for stocks, but one risk to Jefferies’ calls on the S&P 500 is that valuations seem a bit high. The firm’s forecast implies that the S&P 500’s total 2022 earnings multiplier—relative to total per-share profit—should be 21.5 times the value of all stocks in the index. This is where the figures are at now, but many are seeing a dip in valuations as bond yields could easily be higher.

The 10-year Treasury yield, at 1.68%, is still negative in real terms. This is well below long-term inflation expectations, which have historically been rare. Strategists at Morgan Stanley have projected forward earnings multiples of 18, given the risk of higher bond yields. Unless there’s spectacular growth in earnings, a 7% gain on the S&P 500 would be very difficult.

But Jefferies refutes that argument, at least for the near term. “As long as the US breakeven inflation curve remains inverted” [negative real yield]“There will be some room for expansion of multiples in equities,” wrote Sean Darby, global equity strategist at Jefferies. The idea is that if the actual return on Treasury debt is negative, then investors will have enough reason to put money in stocks.

Ultimately the index may keep climbing from here. It’s just that tangible gains are highly dependent on strong profit results.

Improvements and Amplifications: A 12% increase in total 2022 earnings for companies in the S&P 500 would raise the total EPS for the index to $233. An earlier version of this article incorrectly stated that a 12% increase would boost profits to $208 for 2021.

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