In spite of the S&P 500 Index trading sideways for most of the last 18 months until very recently, the advance from the financial crisis low has been strong. A part of the return generated from equities has been the fact the forward P/E multiple has expanded from low double digits to just over 17 times earnings.
In a low interest rate environment stocks tend to trade at higher P/E multiples. The current forward multiple on the S&P 500 Index is certainly not low; however, the current forward P/E level is not giving off a signal of overvaluation either. Importantly, going forward, we believe growth in stocks will need to be driven by growth in earnings since a large part of the return from multiple expansion is behind us.
Not only is earnings growth obviously important, company revenues need to see growth as well. As the below chart shows, expectations are pointing to stronger earnings growth as one looks one year into the future and top line sales are expected to grow as well. We believe the equity market's strong recovery from the February low earlier this year is partly due to the improved outlook for corporate earnings and revenue growth. The equity markets seem to be anticipating this better environment.
In a post written a few days ago, Value Stock Outperformance May Indicate Stronger Economy Ahead, I highlighted the fact analysts are projecting Q2 2017 (one year forward) earnings growth of 15.3% for the S&P 500. Equally important, the top line is anticipated to return to growth as well.
Lastly, the market recently broke out of its 18-month trading range on a near parabolic move to the upside. It would be nice, and expected, to see the market consolidate some of these gains, but positively, selling volume does not seem to be taking hold.
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