Stocks: Can the S&P 500 Gain 50% By 2017?

Today's ADP employment report, which prefigures Friday's report from the Labor Department, was a disappointment: The gain in private payrolls of 185,000 came in lower than the low end of the consensus range (the consensus forecast was 210,000). Despite this (or perhaps because of it -- the result favors the Fed pushing back its first rate rise), stocks are in the black on Wednesday, with the Dow Jones Industrial Average (DJINDICES: ^DJI) and the broader S&P 500 (SNPINDEX: ^GSPC) up 0.06% and 0.44%, respectively, at 1 p.m. EDT. The Nasdaq Composite was up 0.90%. 

Source: Keppler & Schwarzmann.

Why do financial journalists let strategists make wild assertions about the stock market unchallenged? Veteran strategist Laszlo Birinyi appeared on CNBC yesterday, defending a report his eponymous company just published, according to which the S&P 500 could hit 3,200 in 2017. Here's what he said: 

Most people don't realize that we are now in the second greatest S&P [500] rally in history and we're actually ahead of the 1990 rally. If the market continues to gain eleven basis points a day as it has for the last six years, two years out or so, we're going to be over 3,000 [...] There's no reason why we can't go back to as much 1990, there's no reason why we can't keep on going.

No reason? What about the objection that the stock market is now somewhat overvalued (or fully valued, at the very least)? Here's how Mr. Birinyi tries to dispatch that rejoinder:         

"The easy money's been made, the market is now overvalued" -- we've heard this for six years [...] It's an interesting thing about [price-to-earnings] multiples: If you go back and you look again, the way I do, that was a big concern going into the 1990 rally. The P/E on the S&P [500] in January 1991 was 18 times [earnings per share].

[Note: On the same basis (using thetrailing-12-months' operating earnings per share), the S&P 500's price-to-earnings multiple is currently 17 times.] 

Contrary to Mr. Birinyi's assertion, there are excellent reasons the market is unlikely to keep rising over the next five years (or two years) at the same rate it has during the bull run of the 1990s (or at the rate since the current bull market began, in March 2009.) Here are two of them.

During the five-year period from 1991 through 1996, companies in the S&P 500 grew operating earnings per share at an annualized rate of 16.1% (and GAAP earnings per share at 19.4%). That figure, which is well above historical growth rates, was achieved following a decade in which earnings had inched forward at the anemic rate of 0.4%. In Jan. 1991, earnings were poised to rebound sharply, like a coiled spring -- the short recession of 1990-1991 would come to an end just two months later. 

Conversely, over the past 10 years, despite the Great Recession, earnings have increased at a pretty respectable clip -- 4.4% annualized (+8.6% over the past five years). As such, it's unlikely that earnings growth over the next five years will come anywhere the performance it enjoyed in the early 1990s. 

Furthermore, between Jan. 1991 and Jan. 1996, the yield on the 10-year Treasury bond fell from 8% to 5.6%, providing a tailwind for stocks. (When the risk-free rate declines, all other things equal, it lowers the rate investors use to discount future cash flows, thus raising intrinsic value estimates.) With the Fed likely to raise its policy interest rate for the first time before the year is out, stocks won't benefit from the same headwind over the next five years -- quite the contrary, in fact. 

Keep calm and temper your expectations
I do agree with Mr. Birinyi when he says: 

It's more a matter of guidance. What we're really trying to tell people is stay with it. Don't let the bad news shake you out. We've heard all the bad news before.