The S&P 500 reached new record highs to start the week, driven by easing geopolitical tensions overseas, a decline in consumer inflation expectations, and reduced concerns surrounding the French elections following recent voting results.
Israel reportedly restarted ceasefire talks with Hamas, alleviating some of the uncertainty that the regional conflict had caused since last fall, including lower oil prices which have eased inflation pressures. Moreover, the “far-right” National Rally party in France underperformed in the second phase of the snap elections, reducing the threat of major policy changes.
The S&P 500 gapped higher at the open, quickly surpassing 5,580 within the first hour. However, the index began to pull back as attention shifted to Federal Reserve Chairman Jerome Powell’s upcoming testimony and Thursday’s Consumer Price Index (CPI) report.
The market then drifted sideways in slightly positive territory for the remainder of the session, ending with a small gain.
"For much of 2024, the S&P 500 has been trading solidly above any fundamentally justified valuations, as a combination of rate cut hopes and AI earnings pushed the S&P 500 to the very limits of forward valuations,” Sevens Report said in a new note.
However, the "market multiple" math has become more favorable for bullish investors. Around July each year, analysts shift their earnings expectations from the current year to the next year. This transition means that the July Market Multiple Table now shows that the market, at current levels, is reasonably valued as long as 2025 earnings estimates are accurate, the note states.
S&P 500 earnings for 2025 are projected to be around $270 per share, significantly higher than the $243 estimate for 2024. While the upcoming earnings season could alter these numbers, they are currently intact.
As a result, the "fair value" of the S&P 500, using next year’s earnings, has now leapt to the mid-5,000 range, Sevens Report highlights.
Importantly, this shift is more than just a “bookkeeping formality.” Analysts value the market based on next year’s earnings, and "next year" now refers to 2025 earnings. Based on these metrics, while the market isn’t cheap, it is no longer significantly above fundamental valuations.
According to Sevens, this change impacts investors in two key ways. First, it does not eliminate the risk of a correction or pullback. The markets remain aggressively optimistic about a soft landing, aggressive Fed rate cuts, and resilient earnings. The net result is a high multiple, still around 20X. If growth slows more than expected or earnings fall, the market will drop. Second, this earnings shift makes the year-to-date gains "stickier" in the event of a mild pullback.
“Put differently, current S&P 500 levels are a lot more justifiable using 2025 EPS (which is legitimate now). So, it’s going to take real, negative news to cause a meaningful pullback in stocks,” Sevens Report wrote.
"Bottom line, the stock market has been trading at very aggressive valuations for much of 2024, and the change in earnings makes current market levels more justifiable. Additionally, it opens a credible path to another 5%-10% rally,” it added.
However, the risks facing the market have not changed. If there is legitimate negative news on one of the four market influences, a drop of 5% is possible. If there is a negative turn in multiple market influences, a drop of 10% or more isn’t just possible but is rather “likely,” the note adds.