Strategists at Jefferies say the S&P 500 can gain 7% over the next year or so. The main element behind that forecast is—yet again—higher-than-expected earnings.
Jefferies strategists published a year-end 2022 target of 5,000 for the broad market benchmark. That represents a roughly 7% gain from the index’s current level—a view underpinned by the firm’s expectation that aggregate earnings per share for the companies in the S&P 500 will come in at $233 in 2022. The baseline view among analysts tracked by FactSet is that the figure will be $220.
That outperformance, if it happens, would mark a continuation of a trend that has benefited investors recently. In the third quarter, S&P 500 EPS was about 10% higher than analysts estimated. While that was less than the beats of above 20% seen in prior quarters, it shows that Wall Street continues to underestimate companies’ ability to generate profits. Analysts are known for making conservative estimates, especially when there is a surge in demand like the one seen in the post-lockdown era.
One element behind Jefferies’ bullish profit forecast is that the economy is still growing at a relatively rapid pace. Economists are looking for U.S. gross domestic product to grow more than 5% in 2022, according to FactSet. While that would be slower than the growth seen this year, it would still be better than the sub-3% expansions seen in recent years before the pandemic.
Jeffreries’ data show that GDP growth of 5%, historically, correlates to earnings growth in the mid single digits to double digits in percentage terms. The math checks out: It would take 12% growth to bring aggregate S&P 500 EPS for 2022 to the $233 Jefferies has forecast.
The aggregate EPS of $233 for 2022 that the firm anticipates also wouldn’t necessarily shock the analyst community. It would be about 6% higher than the aggregate analyst estimate, and according to Credit Suisse data going back to 2016, companies often beat earnings expectations by about 6%.
That is all good for stocks, but one risk to Jefferies’ call on the S&P 500 is that valuations seem a little high. The firm’s forecast implies that the S&P 500’s aggregate 2022 earnings multiple—the value of all the stocks in the index relative to total per-share profits—should be 21.5 times. That is where the figure is now, but many see valuations coming down because bond yields could easily head higher.
The 10-year Treasury yield, at 1.68%, is still negative in real terms. It is well below long-term inflation expectations, a rarity historically. Morgan Stanley strategists have forecast a forward earnings multiple of 18, given the risk of higher bond yields. That would make a 7% gain on the S&P 500 very difficult unless earnings rose spectacularly.
But Jefferies counters that argument, at least for the near term. “As long as the US Breakeven inflation curve remains inverted [negative real yield], equities will have some room for multiples to expand,” wrote Sean Darby, global equity strategist at Jefferies. The idea that is if real returns on Treasury debt are negative, investors will still have ample reason to put money into stocks.
Ultimately, the index can keep rising from here. It’s just that solid gains are highly dependent on strong profit results.
Corrections & Amplifications: Growth of 12% in aggregate 2022 earnings for companies in the S&P 500 would lift total EPS for the index to $233. An earlier version of this article incorrectly said 12% growth would boost profits for 2021 to $208.
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