The S&P 500 is up 27% from its Christmas Eve low, and 19.3% this calendar year through the close on Friday – not including dividends. Last December, our forecast for 2019 was 3,100. We're just 3.7% away.
As a result, and in combination with our continued bullishness, we are raising our year-end 2019 S&P 500 target to 3,250 from 3,100, with the Dow Jones Industrials Average now estimated to finish the year at 29,250.
Our starting point for setting a stock market target is always our Capitalized Profits Model, which continues to scream BUY.
The model takes the government's measure of profits from the GDP reports divided by interest rates to measure fair value for stocks. It looks at every quarter dating back to the early 1950s and we let each of those quarters tell us where the stock market would be today if equities had increased as much as the ratio of profits to the 10-year Treasury yield. We then take the median of all those predictions (each historical quarter generating its own prediction) to estimate fair value today.
Using a 10-year Treasury yield of 2.03% combined with corporate profits from the first quarter suggests a fair value on the S&P 500 of 5,080!!! This is absurd, and the market will not price it in because it knows the Fed is holding interest rates artificially low.
In fact, the stock market has been significantly below our model's estimate of "fair value" for a decade because everyone knows that interest rates are artificially low. In other words, our model says that the analysts who argue that asset values are in a bubble because of the Fed are wrong. If the market fully incorporated these low rates it would be significantly higher.
Another way to think about this is to ask what interest rate would put the market at fair value with current corporate profits. The answer is a 10-year yield of 3.45%, which is an interest rate we haven't seen since early 2011 and doesn't look likely anytime in the near future.
The interest rate that would make 3,250 fair value is 3.175%, which is also higher than yields are likely to hit. Moreover, corporate profits are likely to rise in the quarters ahead, which suggests room for equities to rise above our 2019 target in 2020 and beyond.
If, on the other hand, corporate profits were to drop by 15% and the 10-year yield rose to 2.7%, fair value would be 3,250, which shows how robust our stock market target is to changes in the economic and financial outlook.