Overall, we think corporate America has done a good job delivering modest earnings gains amid significant headwinds, including tariffs and trade uncertainty, slowing growth in Europe and Japan, and a strong U.S. dollar. Roughly 40% of S&P 500 profits are generated overseas and are therefore sensitive to global trade, international economies, and foreign exchange markets. Over the past two months, EPS estimates for the next four quarters fell about 2%, in line with historical averages and an impressive feat given the various headwinds.
Maintaining S&P 500 Fair Value Target
After exceeding our fair value target in July, stocks have struggled with trade uncertainty and recession fears related to the inverted yield curve. Long-term interest rates have dipped below short-term rates, historically a leading indicator of recession, though with varied and relatively long lead times. Although we have lowered our earnings forecasts, we believe potential Federal Reserve rate cuts, mild inflation, and lower market interest rates support higher price-to-earnings ratios (P/E) for stocks. We look for a price-to-earnings multiple (P/E) of slightly over 18 on $165 in S&P EPS to get us back to the 3,000 range on the S&P 500 by year end.
Conclusion
We reduced our 2019 S&P 500 EPS forecast in August to reflect increased risk to economic growth and corporate profits from the ongoing trade conflict between the United States and China. Although we continue to expect resolution later this year or in early 2020, the odds of a more prolonged dispute have risen. As a result, we believe it is prudent to be somewhat conservative in our forecasts until we get more clarity on trade.
John Lynch is chief investment strategist at LPL Financial.