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This Is Why the S&P 500 Will Rally Big Into the End of 2018

S&P 500 - This Is Why the S&P 500 Will Rally Big Into the End of 2018

Source: Sam Valadi via Flickr

The stock market has been on an epic run. Since the 2008 Recession, the S&P 500 has gone on its longest bull run ever and has risen by more than 300% during that stretch.

But, with the S&P 500 at all-time highs, many market observers are worried. Rising trade tensions have some concerned about a global economic slowdown. A strong dollar has others concerned about international demand headwinds. Some are worried about rising debt levels, while other pundits are concerned about valuation.

Needless to say, eventually those bears will be right. We’ve been on an economic and market uptrend for a decade now. Eventually, a black swan will appear, end that uptrend, and markets will fall.

But, those bears won’t be right today. Nor will they be right tomorrow, or any day soon.

For the foreseeable future, this market will only grind higher, led by the giants who got it here. Given reasonable valuation levels, strong economic growth and a healthy consumer, I reasonably see the S&P 500 hitting 3,100 by year end, implying another 5%-plus upside over the next three months.

The Economy Is Healthy

Perhaps the No. 1 reason that the S&P 500 will continue to grind higher is that the economy is healthy right now, and projects to be healthy for the foreseeable future.

U.S. GDP growth hit 4.1% last quarter, the fastest growth rate since 2014. A large part of this has to do with tax cuts, but it also has to do with the economy finally and fully shaking off the rust from 2008.

Many pundits expect this economic expansion to end given the historical fact that expansions don’t normally last this long. But, the recession that preceded this expansion was also larger than usual, and often considered to be the worst recession since 1929. Following the Great Depression, the economy’s cumulative GDP growth from 1934 to 1944 was over 100%.

Since 2009, cumulative GDP growth in the U.S. has been under 10%. Thus, in historical context, this economy really hasn’t come that far since the Great Recession, and further gains look sustainable.

The Consumer Is Strong

The biggest part of the U.S. economy is consumer spending. So if you want to know where the economy is heading, look at the consumer.

Right now, the consumer is very strong. Consumer confidence is at near two decade highs, while consumer spending is robust with retail sales up 6% year-over-year over the past three months.

This robust consumer strength should persist. By most metrics, the consumer isn’t overstretched. The personal savings rate is at 6.7%, way above where it was before prior recessions. Meanwhile, household debt to GDP is below 80%, far off the near 100% levels it was at in 2007-08. Thus, the consumer has plenty of firepower to remain strong for the foreseeable future.

So long as the consumer remains strong, the economy should remain strong. So long as the economy remains strong, the S&P 500 should head higher.

The Leaders Are Still Growing

The market is nothing more than a composition of a bunch of companies. Fortunately, the biggest companies in the market also look healthy and strong here.

The stocks that led the market here are the big tech names, like Facebook (NASDAQ:FB), Amazon (NASDAQ:AMZN), Apple (NASDAQ:AAPL), Netflix (NASDAQ:NFLX), Nvidia (NASDAQ:NVDA) and Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL). All of those companies look good here and now. Valuations are mostly reasonable, and where they aren’t obviously reasonable as is the case with Netflix and Amazon, growth is huge.

Also, many would argue that the class of “Junior FANG” stocks like Square (NYSE:SQ), Shopify (NYSE:SHOP), Twilio (NASDAQ:TWLO), Axon (NASDAQ:AAXN) and others are just getting started. There are also the red-hot cloud kings like Salesforce (NYSE:CRM) and Adobe (NASDAQ:ADBE), which aren’t showing any signs of weakness, and a big rally playing out in retail thanks to consumer strength. High-impact retail stocks like Walmart (NYSE:WMT), Target (NYSE:TGT), Costco (NYSE:COST), Home Depot (NYSE:HD), Macy’s (NYSE:M) and Nordstrom (NYSE:JWN) have all been big winners recently.

Overall, between tech and retail, it looks like there is enough fundamentally driven firepower to keep the market in rally mode for the next several quarters.

The Valuation Is Reasonable

The biggest knock against this market is valuation, as the widely followed Shiller price-to-earnings multiple is at levels not seen since the Dot Com Bubble.

But, the Shiller P/E multiple incorporates noise from 2008 and doesn’t incorporate tax cuts, so it is rather meaningless in the big picture. If you throw out 2008 noise and incorporate tax cuts, the valuation picture becomes much more positive.

Since 1995, the median trailing earnings multiple in the S&P 500 is nearly 22. But, that includes a bunch of big multiples from the Dot Com Bubble and some abnormally high trailing multiples during 2008-09. If you exclude those time periods, the median multiple for the S&P 500 since 1995 is roughly 19.

Earnings this year for the S&P 500 are expected to come in around $162 per share. Applying a median 19 multiple on that, you arrive at a reasonable year-end price target for the S&P 500 of nearly 3,100.

Bottom Line on the S&P 500

Eventually, the bears will be right about the stock market. But, not today, not tomorrow and not anytime soon. Over the next several months and quarters, the outlook for this market to head higher is quite favorable thanks to economic strength, consumer strength, single-stock strength and reasonable valuations.

As of this writing, Luke Lango was long FB, AMZN, AAPL, NFLX, NVDA, GOOG, SHOP, ADBE, WMT, COST, HD and M. 

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