On November 10th, I wrote a piece here, and posted it to Forbes.com with the title: “The Trump Effect Will Make Stocks Extraordinarily Cheap.”
With the Dow now closing in on 20k, people continue to debate whether or not the market is overvalued, and if so, whether or not it will end badly.
For some perspective, I want to revisit that piece that outlines my simple, fundamental and technical reasons that argue stocks remain undervalued and should go much, much higher from here.
From November 10th, two days after the election:
“I’ve talked in recent days about the ‘Trump effect’ and the welcome sight of a pro–growth government.
We now have a government in the U.S. that has the will and mandate to pick up the baton from the central banks and inject pro–growth medicine into what has been a patient on seven years of life–support.
With that, markets are beginning to reflect what America looks like with incentives and the DEMAND in place to produce, to build, to spend, to hire and to invest. The Dow hit a new record high today. The S&P 500 index that measures the broad stock market is close to record highs— now about than 225% higher than at its crisis–induced 2009 lows.
That sounds like a lot of success already. As we know there’s been a big prosperity gap in the real economy—with stagnant wages for over two decades and underemployment, to name a few. But there’s still a massive prosperity gap in the valuation of the stock market.
Remember, if we look at the peak in the S&P 500 from 2007 and apply the long term annualized return (8%) to that pre–crisis peak, we should be closer to 3,400 in the S&P 500 by the middle of next year. That’s 57% higher than current levels. And that’s the prosperity gap that has yet to be closed in this nearly decade long crisis period. With a pro–growth government coming, we should see that gap close in the coming years. And that means there will be a lot of money to be made in stocks, in a movement to restore prosperity in the real economy.
In addition to the above, remember this: The P/E on next year’s S&P 500 earnings estimate is about 16.5, in line with the long–term average (16). As I’ve said, we are not just in a low-interest-rate environment, we are in the mother of all low–interest–rate environments (near ZERO).
With that, when the 10–year yield runs on the low side, historically, the P/E on the S&P 500 runs closer to 20, if not north of it. If we multiply next year’s consensus earnings estimate for the S&P 500 of $131.43 by 20 (where stocks to be valued in low rate environments), we get 2,628 for the S&P 500 by next year—22% higher. That doesn’t include the prospects of the denominator in the P/E ratio GROWING. If we indeed get growth closer to 4% from pro-growth policies, that earnings estimate will be much higher. And the S&P 500, relative to history, will look extraordinarily cheap!
With this in mind, we may very well be entering an incredible era for investing—after a long slog. And an opportunity for average investors to make up ground on the meager wealth creation and retirement savings opportunities of the past decade, or more.”
Stocks have, of course, been on a tremendous run since early November, when I wrote this piece. And because of that, and because of the psychological effect of a number like Dow 20k, people think stocks have come too far too fast. But this simple analysis above argues that it’s just getting started, and has a long way (higher) to go.
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