Recent optimism in US stocks, particularly the S&P 500, has led to a "full-fledged risk-on mode" with improving sentiment and a broadening rally beyond the "magnificent seven" tech stocks. While investing for the long term is generally advisable, current valuations, such as the S&P's 12-month forward price/earnings ratio at 20 (15% above its 30-year average), make stocks hard to recommend for many. The equity risk premium is at its lowest in a decade, suggesting investors are thinly compensated for taking on equity risk. JPMorgan strategist Marko Kolanovic believes equity valuations are pricing in continued expansion and monetary easing, rather than just a soft landing.
Despite this, several major banks have upgraded their end-of-year S&P 500 forecasts. Evercore ISI, for instance, raised its forecast from 4,750 to 6,000, implying a further gain of nearly 10% over the next six months. Goldman Sachs, Citigroup, and UBS also increased their targets. FactSet's "bottom-up" price target, aggregating analyst estimates, suggested an 18% upside from current levels as of late June, pushing the index to 8918. This optimism is partly fueled by strong underlying earnings growth, with analysts modeling aggregate earnings-per-share growth of 25.3% over the next year and 25.4% over the next five years.
However, this rally inspires doubt among some. Inflation remains a threat, interest rates are still rising, and recession risks persist. Corporate profits peaked a year ago, and the current rally is largely driven by valuation multiple expansion rather than organic earnings growth, a flimsy basis vulnerable to shifts in sentiment. Competitively, a risk-free two-year US Treasury pays 5%, and investment-grade debt yields 5% to 6%, offering attractive alternatives, especially given the low equity risk premium. While bears are retreating, and a new bull market may be forming, full-throated bullishness is rare, with many strategists emphasizing caution and suggesting that risk-adjusted returns for large-cap stocks might struggle to beat fixed income or money markets.
