The Fu-gaze of Year End Targets
As we close out another year & start the next, investors listening to the news will hear plenty of individuals across the industry give pitches of their expected year-end target. Sure, it is smart to have an idea on where you think things could go as a whole. Does, and should this include a “price target” for the S&P 500? I would argue they do more harm than good to the average investor listening. Why? It is the ambiguity of the whole situation. No one knows what the investing environment will be like in six months, nonetheless one year away. Compounding the situation, we have arguably been living through the most dynamic and disconnected investing environment in decades.
First off, lets handle the earnings situation. When looking at a company, you can gather information on possibilities of what their earnings are going to be in the quarter or year ahead using a company’s “forecast”. This can be useful, but honestly no one knows what the future will hold. Nonetheless, lets’ assume you’ve come up with an amount of money you think they will make (the earnings). Once you have that, you divide the price of the stock by that amount of expected earnings to get to that estimated “P/E”. I like to think of it as years left to make your money back if the company has a similar amount of earnings going forward. Now think about trying to do this process for lets say twenty companies over the next year. This would be extremely hard to do in an accurate manner to even just find what you think they’ll earn, nonetheless what price people would be willing to pay for each by December 2023. Now lets expand that twenty to the 500+ names in the S&P 500. You are now in the realm of the Fu gaze.
Every company in the S&P 500 is weighted based on Market Cap (# of Shares x amount of shares outstanding). So you take your estimated earnings of each company. Then, try to estimate how much their “weight” of those earnings will be in the S&P 500 in twelve months. Weight meaning their estimated market cap, divided by the estimated total market cap of all of them. To find that weighting, you have to find what the total market cap of all of the stocks could be. Sure, you could use today’s price and take an educated guess on where prices will go using some probability equation, but that is all it could ever be. No one knows what the mood of society will be twelve months from now towards even one of these companies, nonetheless all of them. Although, you can take an educated guess if things are at an extreme. I would say this though, VERY FEW (IF ANY) MADE ACCURATE PREDICTIONS IN 2021. Over the long-term (multiple years) the price relates to how the business does, but price targets in the short term are based on SENTIMENT. This is the collective mood towards a certain asset at a given point in time. I would argue you have a better chance at going through all the companies and estimating the earnings than what the price could be.
Also, lets take a look at the 2007-2010’s S&P 500 price to earnings ratio. Below is a list of the P/E on a given day each 6 months apart (Source 1):
Date P/E S&P 500 Price
1/1/2007 17.3x 1416
6/1/2007 17.7x 1536
12/1/2007 22.2x 1472
6/1/2008 24.9x 1385
12/1/2008 60.7x 816
6/1/2009 122.4x 943
12/1/2009 21.9x 1109
6/1/2010 15.4x 1070
Notice how the earnings deteriorated in such a way that although the index was going down, the P/E was NOT decreasing (at the time, was quite skewed by a few companies with HUGE losses instead of earnings). In reality, if you had decided to buy only if the index was below 18x earnings you would have purchased leading up to the crash thinking you were getting a slight deal and never bought until the recovery of price was in full swing. The bottom of the market was in March of 2009 and by June of that year you would have seen that 122x earnings. I would imagine if someone invested with this strategy they at least would’ve thought about selling because “how expensive the index looked”. Even though in reality it was at a discount to where it was at in 2007 for the long-term investor.
Now leading up to 2022 was one heck of a learning lesson. I saw a car company IPO north of $100 BILLION DOLLARS in November of 2021 and they didn’t even have an up and running production line (Yes, this is Rivian). At this point, people were euphoric about just owning something because of what it was going to do, not what it does today or even in the near-future. Now, this company is not in the wrong for doing this. If I was the owner, I would have thought of doing the same dang thing. I would argue Wall Street was. Why? Rivian’s IPO was valued based on all of the electric car companies current multiples at the time. At that point, Tesla might as well have been at 1,000x earnings the way analysts were raising price targets. Don’t even get me started on the other ones like Lucid, etc. Sadly, if the price kept rising I think the analysts would have still kept raising price targets and validating it by an ever increasing euphoric future. Maybe that future ends up playing out, but it sure is going to take TIME and that is the problem. Not a single person can make an accurate guess on how long all those dreams would take to make into reality. It was like clockwork for basically 2-3 years and especially in 2021. Don’t get me wrong, Tesla is a GREAT COMPANY. A great company does NOT mean that it is worth owning at the price but analysts kept raising their price targets with the stock almost as if they were chasing it “to the moon”. It is never about what you own, but how much you pay for it.
With all the euphoria that was spreading across the markets, smaller companies were getting destroyed. Nonetheless, the S&P’s price kept marching higher. When 2022 came, the oxygen (virtually non-existent interest rates) was removed. Analysts were in a metaphorical lounge chair thinking that interest rates must be low long into the future because they had been for YEARS up to that time. Also, the Federal Reserve seemed to give signals of low rates far into the future too. As of now, we all know that was not what the future would bring. Even where we stand today, rates are up an ungodly number on a percentage basis from a year ago but on an absolute basis they’re still VERY LOW. In my mind, no one with a brain should be guessing how this dynamic plays out in the next 12 months. All I know is that no matter what happens, it will effect stock prices. In what way, that is the question for only father time himself.
So maybe I lost you within these thoughts of mine, but if you are going to take something away from this, take this: No one knows the future and just because someone is a “professional” in an industry does not mean they are right. If anything, the professional is incentivized to keep the party going. Beware of a investment community that all agrees on where we are going. Maybe they are right for now, but over time this could prove not to be the case. Don’t let fear drive you in these times, no one knows what the future will bring. Know though that today you can put the same amount of money to work with more of a bang for your buck. The question is, will there be a better opportunity?
Riley Sisson
Branch Manager, RJFS
(1) https://www.macrotrends.net/2577/sp-500-pe-ratio-price-to-earnings-chart
Any opinions are those of Riley Sisson and not necessarily those of Raymond James.
The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete, it is not a statement of all available data necessary for making an investment decision, and it does not constitute a recommendation. Future investment performance cannot be guaranteed, investment yields will fluctuate with market conditions.
The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. Past performance may not be indicative of future results.
