From the January newsletter from Provident Investment
The S&P 500 has continued its run, returning more than 17 percent year to date through November. The steady rise this year, with only modest turbulence, has increased the number of market observers highlighting an “overheated” market where investors have become complacent.
Not to completely dismiss these concerns, but a fact-based analysis helps to put the current situation in perspective. Returns in 2017 have generally been driven by valid reasons, including global economic growth, rising corporate profits and the likelihood of tax reform. The most recent report from the Labor Department showed nonfarm payrolls in November rose a solid 228,000, the 86th consecutive month of expansion. Steady hiring has brought the unemployment rate to 4.1 percent, a 17-year low.
This positive backdrop is expected to produce 10.2 percent earnings growth for the S&P 500 in 2017. Consensus estimates put Q4 growth at 10.6 percent, which would mark the third time in the past four quarters we experienced a double-digit increase.
Looking ahead to 2018, earnings for the S&P 500 are expected to rise approximately 11 percent, to $146. [With tax reform passing], estimates suggest it would add approximately $10 to composite earnings. This would bring the forward P/E multiple to 17x, higher than the five-year average of 15.8x but far from levels divorced from rationality.