Rising Bond Rates Will Reduce S&P 500

This article was written exclusively for Investing.com.

Low interest rates and excessive rise expectations brought it to record highs. Now, however, bond yields are rising, which means that the coefficients will decrease. Exactly how much these coefficients should fall is a concern, as the drop could be quite high.

According to Refinitiv data, the S&P 500 is trading at about 18 times the 2023 earnings forecast of $ 219.90 per share. This ratio is well above the historical average of 14.9 since 2014 and indicates that future earnings growth expectations are very high. If the price-earnings ratio returns to this average over time, the value of the index drops to 3,256, 16% below its 3,915 value on March 18.

For the S&P 500’s price-to-earnings ratio to drop to 14.9, earnings would need to rise to $ 262.41 per share by 2023 or 2024, about 19.3% above current estimates for 2023, which is likely to happen. low. In fact, most of the earnings growth is expected to be experienced in 2021, with an increase of 25.5% towards $ 172.07. Estimates are for earnings growth to slow to 15.2% in 2022 and 11% in 2023.

Earnings growth should have risen above 32.4% in 2023. Since 1985, earnings have grown by over 30% in two periods: 1989 and 2011-2012. It seems unlikely that earnings will grow by over 30% in 2023. To reach $ 262.41, there must be a growth of 19.2% in 2024. This is a difficult goal to reach after two years of decelerating growth.

This does not mean that the S&P 500’s price-earnings ratio should drop by 14.9 times the 2-year earnings forecast. But it shows how much earnings growth is being priced in the market, and also points out that market expectations are much higher than analysts’ consensus forecast.

Low interest rates also play an important role in the valuation of the S&P 500, making a measurement much more challenging. But even when we take into account low interest rates, the S&P 500 is almost the same overvalued level.

Using 18-month future earnings estimates to determine the S&P 500’s earnings rate is one way to measure valuation against interest rates. The index currently has a yield rate traded at a premium of 3.2% on the Treasury bond, based on 18-month future earnings estimates. The index saw levels this much or lower only in January and October of 2018.

Now, rising bond yields along the curve will begin to put pressure on the index and increase the rate of earnings by lowering the coefficients. The S&P 500’s earning rate was about 5.7% when the 10-year bond last yielded around 1.75% interest. This is almost 85 basis points above the S&P 500’s current 4.85% earnings rate. This lowers the price-earnings ratio of the S&P 500 from 20.6 to 17.5, based on the 18-month future earnings forecast of $ 192.82, and gives the index a value of 3,374.

It is clear that the prospects for future earnings growth for the S&P 500 are excessively high. Add to this the low interest rates, which lead to a dramatic increase in the S&P 500’s earnings coefficients. At this point, it is logical to think that the coefficients should decrease and this will be followed by the fall in prices, although interest rates will continue to rise and possibly continue to rise.

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