It is all about the earnings.
Canaccord Genuity equity strategist Tony Dwyer on Tuesday boosted his estimate for S&P 500 operating earnings per share, leading him to move his 2018 target for the large-cap benchmark to 3,200 from 3,100, which was already one of the most bullish calls on Wall Street.
In a note, Dwyer said Canaccord raised its 2018 earnings estimate to $160 a share from $155, leading to the 3,200 target based on expectations for a price-to-earnings ratio of 20. That would mark a 17% rise from the S&P 500’s
close at 2,734.62 on Monday and would be more than 11% above the record close of 2,872.87 set on Jan. 26.
He also set his target for 2019 at 3,360, based on expectations for a simple nominal growth rate of 5% for operating earnings, which would take them to $168 a share.
Dwyer said the first-half volatility, which included a February plunge that knocked the S&P 500 and the Dow Jones Industrial Average
down by more than 10% from their record highs, leaving them in correction territory, “sets the stage for the next leg higher.”
Dwyer said excessive optimism in markets and economic assumptions had led him in January to look for a bumpy first half. “As a result, we thought SPX gains would be second-half loaded, and we are nearing that part of the year, and that euphoria for both the economy and market have faded a bit,” he wrote.
The bottom line, meanwhile, is, well, the bottom line. In other words, the market “correlates most directly to the direction of EPS,” or earnings per share, Dwyer said. And with EPS expected to grow over 20% in 2018 and keep growing in 2019, the stage is set, he said (see chart below).
Why so confident on EPS, though? Dwyer said EPS moves with the direction of the economy, and while global growth is slowing, recent data show the U.S. picture remains very positive, with the Atlanta Fed’s gross domestic product tracker now signaling 5% annualized growth for the second quarter.
The economy, in turn, moved with the availability of credit, which is driven by the slope of the yield curve. Dwyer expects the Federal Reserve to deliver a quarter-point rate increase later this month, but thinks the central bank will be “very hesitant” to raise very aggressively out of fear of inverting the yield curve—a situation in which short-dated yields, such as on the 2-year Treasury note
move above longer-dated yields, such as on the 10-year note
Dwyer also expects core inflation to remain low, which would help keep the Fed in check.
It won’t necessarily be smooth sailing, Dwyer said, with geopolitical and midterm election worries likely to continue to make for volatile conditions, though such episodes should be viewed as buying opportunities.
“Throughout this cycle, each intermediate-term correction feels like the fundamental and tactical backdrop is at risk, only to ultimately realize that positive influences that drive our core thesis still exist,” he said.