Good Afternoon! I wanted to share some quick math on how we think about the market and what we plan to do.
The complex market can be broken down into two parts; earnings and valuation.
Earnings
What do all of the companies in the S&P 500, combined, earn in a year – That is the S&P 500’s ‘earnings.’
Valuation
The common phrase people say is; “The S&P 500 trades at 21x earnings today.” The price-to-earnings ratio is the ratio of price divided by earnings (P/E).
The S&P 500 has commonly traded at 16x price-to-earnings over the long-term (think decades)
Standard & Poor’s (S&P) publishes earnings of the consolidated market and expected EPS (earnings per share). Large banks, like Bank of America and Goldman Sachs, aid in forecasting these earnings. It’s because of this, we can begin to value the market as described below.
Consensus EPS for the S&P 500 this year and next:
But wait…
Two things are happening:
1) Interest rates should rise as the Federal Reserve tapers.
2) Taxes should rise in 2022.
Both of these are bad for valuation and earnings. Thus, our 2022 year-end $225 consensus EPS number may come in at $220. Higher interest rates also pressure valuation multiples; a 21x price-to-earnings ratio today should be driven down to 20x or 19x (closer to its long-run average).
Let’s say we get $220 EPS in 2022 and a 20x PE, that’s an S&P market at $4,400 vs ~$4,405 now. (keep in mind, this is December 2022 target)
All in all, the markets are priced to perfection with 1) higher rates and 2) taxes coming. Expect some volatility and muted returns over the next 12-24 months.
What to do about this?
- We play defense by playing offense! Our firm has been writing structured notes and investing into private deals, all with the target return of 10-15% and less market volatility. Private investments and income notes targeting 10-15% should beat a public market that may return 4-6% for the next 12-24 months.
- Secondly, we continue to write options on stocks/ETF’s that should provide extra income for you.
