The high S&P PE ratio points to an overvalued US equity market. However, the reverse earnings gap remains below historical standards. This is not just due to low interest rates: profits have risen strongly during this economic cycle.
Companies are using innovative, new methods to improve production processes and increase productivity. Earnings can continue to grow steadily. Rolling back on Dodd-Frank may provide a further tailwind to the recovery.
Stock market valuation metrics can sometimes miss the bigger picture. Ultimately, this economic recovery may run for several years because there is no underlying leverage problem (yet). We continue to expect that interest rates will rise four times this year. However, this will not derail equities. The S&P 500 could still reach a high of 3,000 in the current bull market.
Summary
- Reverse earnings gap still down from historical averages
- Profits have risen strongly during this cycle: earnings growth could rebound further
- No underlying leverage problem means economy has legs to run – this will be positive for the stock market
