Where The Market May Be Going -- And Why I'm Not Worried
By Amber Hestla | February 02, 2018 |

Stocks appear to be overvalued, but there is still room for additional gains. In part, that is due to all the uncertainty in the markets at the beginning of the year. Even analysts at Wall Street's biggest firms find themselves trying to understand the new environment.

Tax reform is now being factored into earnings estimates. And while analysts still aren't sure what the full impact will be, there is consensus that earnings will be higher. 


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You can see that consensus in the chart below, which shows earnings per share (EPS) estimates for the S&P 500 from three large financial firms. To develop these estimates, analysts weight the earnings of individual companies using the same weights used in the price index.

Increases range from just $7 per share at Goldman Sachs to $16 a share at UBS. But in all three cases, almost all of the increase is the result of lower tax rates.

Some growth will also come from an increase in share buybacks -- yet another effect of the tax reform package, which has already started to result in companies bringing cash back to the United States from other countries where it was parked to avoid higher U.S. tax rates. Some of that cash is expected to be used to increase dividends and buy back more shares.

Economic growth, another objective of tax reform, is expected to contribute a small amount to the increase.

Sure, it's possible analysts are being too optimistic at this point. But, to assess the impact of the new law, let's assume that the changes outlined in the tax reform could amount to a $10 gain in the S&P 500's EPS.

Based on the market's price-to-earnings (P/E) ratio of about 20, that $10 increase in EPS translates to a 200-point gain for the index. Using the lowest estimate of $150 per share, a P/E ratio of 20 indicates the S&P could reach 3,000. That's nearly 7% higher than its current value.

Bottom line: This means we should see higher prices in the stock market again this year. 

There could be a correction, or course, which is generally defined as a decline of more than 10%. We haven't experienced a correction since 2016.

It's actually been quite a while since stocks pulled back by 5%. Prices haven't fallen that much in more than 380 trading days, the third-longest streak without a 5% pullback since 1930, according to a new note released by Goldman Sachs.

I believe a decline will actually be a good buying opportunity. 

Regardless, I continue to believe that there are great trades in this market -- especially with the strategy my subscribers and I use over at Maximum Income. That's because what we do works in just about any market environment.

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This article originally appeared on StreetAuthority.

 

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