This article is written exclusively for Investing.com
The stock market today and the late 1990s have so many similarities that it can be a little scary at times. The data is just there for everyone to see, and what it suggests is that this current stock market must go through a significant period of multiple contraction.
Earnings growth is expected to decline dramatically next year, and in the past, when growth rates fell, earnings multiplication also increased. Should that happen, it will likely lead to an assortment-tied stock market at best. If earnings expectations turn out to be declining, then the stock market is likely to follow those earnings expectations lower.
End of Cycle
The path of the on an 18 month forward PE basis is relatively similar, if not nearly identical, to that from 1998 to 2002. Based on this analog is today's S&P 500 is halfway through its life cycle. This means that we are now at the top of multiple expansion. The next phase of the cycle should lead to the PE multiple for the S&P 500 to shrink or fall.
Growth rates are falling
It is not only the life cycle that is likely to cause the PE multiple to fall. The trend in the earnings growth forecast for the year 2001 shows that once the growth rate began to decline in the fall of 2000, the PE multiple on the S&P 500 began to rapidly contract. It fell from around 23 to almost 14 in the summer of 2002. It wasn't until growth trends for 2003 started to pick up that the S&P 500 multiple began to expand again.
The Analog
It may be far too early in the cycle to reach a solid conclusion, but given the trends already observed, it may be worth examining the possibility To examine that the growth rate of 2022 follows the same path as in 2001. The growth rate of revenues in the S&P 500 in 2022 has fallen quite dramatically in recent weeks, from about 17% to about 12% now. Additionally, given that analyst consensus estimates start high historically and decline over time, the growth rate for 2022 could continue to decline if that same scenario plays out. Should that happen, you might expect the PE multiple of the S&P 500 to continue to evolve lower as well, as it did in 2000 and 2001.
S&P 500 Earnings Estimates
Estimate Trends
The other part of the equation here is the trend in the income estimates themselves. Rising earnings expectations lead to higher values ??for the S&P 500, while falling estimates lead to lower values. Earnings expectations for 2021 and 2022 have risen consistently in recent months. However, there seems to be some indication that the rate of change may be slowing. After the big rise in 2022 estimates in April and the first week of May, estimates changes have slowed dramatically. It may be because analysts are waiting for the earnings season to begin the next upgrade cycle, or the upgrade cycle is nearing the end.
Interestingly, earnings developments for 2021 and 2022 are following a similar path to those of 2004 and 2005. If so, the S&P 500, as noted earlier, will at least trade sideways. in the next months. As the earnings trends of 2004 and 2005 leveled off, so did the S&P 500's advance at that point.
It appears that from a few perspectives, unless the S&P 500 can maintain its high PE multiple, the growth rate and current earnings trends, the index will most likely be range bound for a while as the PE- ratio is shrinking to account for slower growth next year. How bad it gets depends entirely on whether income developments also start to deteriorate.
