The S&P 500 is closing in on 4000. What happens next.

  • By Jacob Sonenshine,
  • Barron's
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The S&P 500 (.SPX) is knocking on the door of the 4000-level milestone. Barring a major negative shock, the index could hit that level fairly quickly.

The S&P 500 has been hovering just above 3900 this week—it closed Tuesday at 3911.23—and is up by 4.1% year to date. Investors expected continued sales and earnings momentum as Covid-19 vaccines have been administered at a daily rate several times that seen in December.

That means states can reopen, a development that could be met by pent-up consumer demand from the excess savings resulting from trillions of dollars in fiscal stimulus. Small businesses will have some cash to rehire workers. On the corporate side, balance sheets are flush with cash for more share buybacks and investment.

The index would only need to gain a bit more than 2% to get to 4,000, which could happen anytime in the next few days. True, valuations aren’t cheap. The equity risk premium on the S&P 500—the excess earnings yield on the average stock against the yield on the safe 10-year treasury bond—is around 3.3%. Historically, that premium averages roughly 3.5%, but the lower it goes, the less attractive stocks become. Still, markets can trade at elevated levels for some time, especially if the fundamentals are brightening.

Rising earnings expectations could boost stocks. Analysts have revised estimates higher recently, but forecasts still look low. With aggregate earnings per share on the S&P 500 tracking at around $42 for the fourth quarter and current-quarter expectations still below $41, according to DataTrek, those estimates should rise.

A reopening economy—with potentially $1.9 trillion of added fiscal stimulus—should result in higher EPS quarter over quarter. Estimates for 2021 EPS could creep toward $180, up almost 3% from current estimates. Even without higher estimates, stocks could keep pricing in rising earnings as the calendar year flips over and 2022 EPS looks to be nearing $200, according to FactSet data. The vaccine-plus-stimulus narrative keeps that momentum alive.

One question for traders is how quickly the index can reach 4000. The answer: pretty fast. Timing is the hardest component to predict, Frank Cappelleri, chief market technician at Instinet, told Barron’s. Still, “bearish formations have failed in recent months,” Cappelleri said. During the S&P 500’s overall rise since September, it takes just days to rebound to new highs after brief dips.

The downside to stocks is fairly significant, though decreasingly likely. If vaccines can’t immunize against new virus mutations, reopenings will be challenged and the recovery story threatened. Slower vaccine rollouts would simply delay reopenings. Both of those scenarios, though, are playing out satisfactorily. Less fiscal stimulus than expected means somewhat less pent-up demand than expected. If inflation expectations and bond yields rise too fast, stock valuations would come under pressure.

Always watch fundamental developments, but the path for stocks is currently bullish.

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