The
S&P 500
has a new—and much higher—price target, and understandably so. The stock market has been on a steady but steep climb this year, and many on Wall Street are just trying to catch up.
Citigroup
strategists seem bold with their forecast: 5000 by the middle of next year, way up from their previous target of 4400 and about a 9% gain from the index’s current level of roughly 4600.
With its new number, the bank is essentially giving companies on the index, collectively, more credit for the earnings growth that they can achieve.
The market has done the same as buying pressure has sent the S&P 500 up about 20% this year. Two key drivers of the gains: artificial intelligence and the Federal Reserve.
First, AI. Big Tech’s advancements have increased the total available market for their goods and services, which in turn has lifted analysts’ estimates for profit growth. At the end of July,
Apple,
Amazon,
Google parent
Alphabet,
Nvidia,
Tesla,
Microsoft,
and
Facebook
owner Meta made up nearly 30% of the S&P 500, up from 21.5% on Jan. 1, according to Dow Jones Market Data. Their combined market capitalization has increased to $11.5 trillion from $6.9 trillion.
Other stocks have joined the party, too, but for a different reason—the Fed. Wall Street had expected that the central bank would pause its interest-rate hikes as the inflation rate declined. And the Fed did skip one increase, in June, but hiked rates by a quarter-point again last week. Now, there’s hope of a pause, even if just that—a pause.
Chairman Jerome Powell is pushing ahead on rates because the economy is showing incredible resiliency. A recession from higher rates, which tamp down economic demand, isn’t happening as proved by the better-than-expected second quarter gross domestic product report. So far, the Fed has so far engineered a “soft landing”—lowering inflation without bringing on a slowdown.
Citigroup’s strategists explain that the healthy economy led them to shift their thinking.
“The new targets reflect increased probability of a soft landing in our scenario approach,” wrote strategist Scott Chronert.
Chronert lays out three potential scenarios for the S&P 500, and the probability that each will happen:
One is that aggregate earnings per share on the index can hit $225 for the 12 months leading into mid-2024, and the index would trade at just over 20 times that number, landing it at 4600. The probability: 50%.
The second calls for even larger profits and a higher multiple, landing the index at 5800. The probability: 40%.
In the final scenario, the Fed keeps increasing rates, the economy hits the brakes, and the market loses confidence, in which case earnings and valuations would drop, sending the index to 3600. The likelihood: 10%.
The strategists arrived at their 5000 target by weighting each scenario by its probability. The 5000 level assumes $230 of EPS for the 12 months leading into the middle of next year.
Their new number isn’t far-fetched. Analysts’ EPS consensus for this year is $218, according to FactSet. Into next year, they expect EPS to grow as sales increase with economic growth and cost increases, such as higher wages, moderate.
Higher sales and lower costs expand profit margins, which is why companies can rake in that number in EPS by next summer. Already, companies are largely beating EPS estimates on second-quarter reports, and earnings will grow so they might not have to beat estimates by that much to reach $230 in total earnings by the mid-2024 date.
Citigroup’s 5000 price target assumes the S&P 500 can trade at just over 21 times those earnings.
A couple of factors make it realistic: It’s a trailing—not forward—multiple, which means it considers earnings that will have already rolled in; the usually-lower forward multiple looks at expected future earnings, which are often larger.
Plus, a trailing multiple in the low 20s has been near the middle of the range since the early 1990s. If the market is confident that companies can keep growing their earnings, it will trade at a healthy—or middle-of-the-road—multiple.
It has been quite a market to keep up with. And Citigroup is making a strong case for more good times. Buying it might be the way to go.
Write to Jacob Sonenshine at [email protected]
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