Dear Investors,
How can we justify a 22x S&P 500 Index P/E?
Our 2023 year-end S&P 500 Index target range is 4300 – 4500 on earnings of $205 for the year. This implies an end of year price-to-earnings (P/E) multiple of 21x – 22x.
Wells Fargo has received a number of inquiries regarding this outlook, and they tend to revolve around the question: “How can we justify such a high P/E?”.
They are forecasting both an earnings contraction as well as an early cycle recovery in prices this year.
In the near term, Wells Fargo expects deteriorating macro conditions and earnings outlooks to weigh on prices and produce bouts of volatility.
However, they see the stage being set for a recovery and a breakout late in 2023 and into 2024 as investors begin to look past the economic troubles to the eventual recovery.
This brings us to a key dynamic to emphasize — stock prices are forward-looking while earnings are lagging.
Imagine today is December 31, 2023.
Will markets be reflecting on the $205 earnings figure in the rearview mirror?
No, they will be looking through the windshield to what lies ahead.
The time frame mismatch between forward-looking prices and backward-looking earnings causes early cycle P/E spikes.
This behavior is consistent throughout history as prices turn higher well in advance of earnings.
The chart above illustrates this point by plotting the trough to peak P/E spike during past early cycle periods.
Of note, our 21x – 22x P/E forecast is a relatively low P/E peak when compared to historical observations.