DIY Market Forecast II – Our Forecast

A week ago we published DIY Market Forecast. This article was unique for us as we did not offer you our opinions and forecasts. Instead, the article provided data and trends but left it to the reader to create their own five-year S&P 500 forecast. This approach appears popular based on the many favorable comments we have received. Of the reader comments, quite a few have asked us what our DIY forecast is.

In a nutshell here is our forecast:

We selected to use the 3% GDP growth table. While we could have easily opted for the 1% table, we give stronger economic growth the benefit of the doubt. Keep in mind, however, if a recession occurs and growth is minus two or three percent for a year or two, a one percent average growth rate will be the better bet for the next five years. Given the probability of that scenario as this economic cycle ages, consider our range of estimates as a top end of possible outcomes.

We then chose a range of profit margins and CAPE valuations that we think are reasonable. In both instances, we believe they will slip from current levels towards longer-term averages. We do consider the possibility that profit margins and CAPE go below average but think the most likely scenario as highlighted in red, is between average and slightly below current levels. We remind that you that current levels in both instances are extreme and unlikely to continue, let alone rise from here.

The table below highlights our DIY forecast. The red shaded area is our “probable” forecast and averages to an S&P 500 forecast of 1707, with a range of 2420 to 1164. The yellow shaded area allows for the two factors to drop slightly below average which historically has been common during market corrections. The average S&P forecast in this scenario is 1172 with a range between 864 and 1512.

In prior articles, we have estimated what fair value for the S&P 500 index would be. In general, our estimates tend to converge around 50% of the current level, which would be approximately 1350.

Accordingly, the forecast detailed above is in the ballpark and further supports our conviction that investors should not take the possibility of a 50% decline lightly.  These are startling estimates, but considering the extent to which current S&P 500 levels are the product of manufactured liquidity-induced speculation as opposed to healthy organic growth, investors should keep an open mind. If we recall prior occasions in March 2000 and October 2007 when market levels were similarly over-extended, the reaction to a 50% decline projection then was met with equal skepticism.

For more on our expectations, please read Why Another 50% Correction Is Possible.