Somehow, it seems our world really was different in November 2016. The most important event that month was the election of President Donald Trump.
Analysts were in almost unanimous agreement. A Trump win meant stock prices would crash.
But, they were wrong.
The S&P 500 Index is up almost 38% since the election.
Not only did markets not crash, but fundamentals are at the same level seen in November 2016.
That’s right. Despite the big price gain, fundamentals are right back to where they were. The chart below shows the price-to-earnings (P/E) ratio of the S&P 500 Index. Now, it’s lower than it was in the months before the election.
As the chart shows, the P/E ratio fell sharply early this year. That decline came in the January market panic when the S&P 500 dropped 11.8%.
The index has recovered since then, but the P/E ratio remains low thanks to a jump in earnings. And that earnings increase arrived on the back of Trump’s tax reform.
Analysts were surprised by the size of the earnings jump. And even now, they remain skeptical of continued gains in earnings. That’s why we are seeing a record number of companies in the S&P 500 beating earnings estimates.
This is a setup for potential gains in the index.
The current P/E ratio, based on expected earnings over the next 12 months, is 17.1. In 2017, moves above 18.5 were rare.
To reach a P/E ratio of 18.5, the index would need to rally about 8%. That assumes earnings don’t increase. But, earnings have been increasing more than expected in the past year. So, the probability of a larger gain is high.
The S&P 500 Index Is up Since the Election
Fundamentals point to more gains in stocks. It’s rare to see the S&P 500 reaching new highs while it’s undervalued. But’s that’s where we are today.
All the pieces are now in place for a strong rally in stocks.
Michael Carr, CMT
Editor, Precision Profits