Inflation and rising interest rates was the big story of 2022. As we approach the end of the year, and the Fed terminal rate of 4.5-5%, people seem to be cheering the death of inflation, but they're conveniently leaving out the growth part of the story.
The most recent update to forward EPS projections is now at 225 EPS for 2023 (https://www.yardeni.com/pub/yriearningsforecast.pdf).
That means that at S&P 4000, we'd be trading at a 18 forward P/E. The historical average over the last 10 years is a 17x forward P/E, but this was with effectively 0% interest rates.
Growth is continuing to slow, and there's a real chance we'll see further earnings revisions to the downside.
In other words, the market is over valued because “Santa rally”, or because the market would rather focus on inflation coming down instead of actual earnings growth and valuation multiples. I called out in a previous post that the market would rally into year end, and possibly into January, but it's likely a Bull trap as all we've really done over the last 2 months is multiple expansion, not real earnings growth.
What do you think is a fair multiple at 4%+ interest rates? I would argue 16x forward makes sense, so on 225 EPS that would make the fair value of the S&P 3600 today. Obviously this isn't a perfect method of valuation and there are many other factors to consider, this is just a framework for how I think about a potential trading range we could see into next year.
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