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The S&P 500 is near 2,400 after gaining more than 11% since the election. Bears are warning of irrational exuberance, but the truth is we could see a gain of 25%, or even more, from current levels.
While it might seem unlikely given the age of the current run, that bullish outlook is based on both history and current events.
The current bull market began in March 2009 -- 97 months ago. That makes this the second longest bull market since World War II. The longest was the 115-month run that began in October 1990 and ended in March 2000.
In percentage terms, this is the third best bull. The current gain of about 250% lags the 417% gain of that bull market that began in 1990 and the 267% gain of the 87-month bull run that began in June 1949.
I know that's a lot of numbers so let's use a chart to place the current bull market in context...
The current market is the bright blue line. We can see that this bull started stronger than most bull markets, but then the pace of gains slowed. I believe this consolidation set up the next leg of the bull market, which I expect to be driven by fundamentals.
Economic news has been improving in the past few months. The latest evidence is the ADP National Employment Report, which showed nearly 300,000 new private sector jobs were created in February.
This is the fourth consecutive month with gains of more than 200,000 jobs.
This report is produced in collaboration with Moody's Analytics. That firm's chief economist, Mark Zandi, noted, "February was a very good month for workers. Powering job growth were the construction, mining and manufacturing industries. Unseasonably mild winter weather undoubtedly played a role. But near record high job openings and record low layoffs underpin the entire job market." A high number of openings and a low level of layoffs indicate the gains could continue.
Rising employment is a sign the economy is turning around. The turnaround seen in the chart above coincides with the election and seems to be based on optimism associated with the change in administration. The question now is what's next.
The answer may lie in tax policy.
There are a lot of hard problems facing Washington. Healthcare will take time, as will many other issues. Tax policy seems to offer the most immediate path to a significant accomplishment for the president and Congress.
President Donald Trump has made a number of proposals related to taxes. Among the most important would be a reduction in the highest corporate income tax rate from 35% to 15%. I am fairly certain tax reform will require negotiations and Trump won't get everything he wants. But the good news is that lower corporate and personal income taxes seem likely.
Lower corporate taxes will have an immediate impact on company's earnings. Standard & Poor's estimates that every 1% reduction in the corporate tax rate could add 1% to the earnings per share (EPS) of companies in the S&P 500.
Current EPS estimates are around $133. If the tax rate drops 5% (to a top rate of 30%), EPS could be about $140. Using that estimated EPS value of $140 and a slightly above-average price-to-earnings (P/E) ratio of 17, the fair value price target for the S&P 500 would be right around 2,380 ($140 x 17) -- exactly where it currently sits. (I believe a higher-than-average P/E ratio is warranted given the increased optimism among small businesses and consumers and the positive outlook for reduced regulations.)
However, Trump isn't looking for a small reduction in taxes... he's targeting a 20% drop. Let's assume he settles for a rate in the middle, a 10% cut. EPS for the companies in the S&P 500 could then be about $146. A P/E ratio of 17 provides a price target of about 2,500. A P/E ratio of 20, which could easily be justified by the rapid growth that would push earnings higher, provides a price target above 2,900.
If companies obtain relief from the regulatory burden and government agencies change their policy of imposing large financial penalties on companies, EPS could rise even more.
Changes in personal income taxes should increase consumer spending and lead to even higher EPS. A target of 3,000 on the S&P 500 is realistic, assuming Washington delivers on its promises. I believe we have until late summer to see progress. If there isn't movement toward tax reform or other significant policy changes by then, the bull market could collapse. If there is change, the bull market could rival the one from the 1990s that many of us fondly recall.
In this environment, I believe companies whose results are sensitive to economic growth may outperform. Among those companies is Advanced Micro Devices (NASDAQ: AMD).
AMD makes x86 microprocessors, the central processing unit (CPU) of many desktop and laptop computers. The company's chips are also incorporated into accelerated processing unit (APU), chipsets and discrete graphics processing units (GPUs) for the consumer, commercial and professional graphics markets. These chips are also used in servers.
These are all massive markets. Gaming represents a $15 billion market... Data centers are a potential $18 billion market and virtual reality is on its way to a $20 billion market opportunity.
You can buy AMD shares outright to play its upside, but that's not what I'm recommending in Maximum Income, my premium newsletter. Instead, I'm suggesting readers make an income trade that allows them to collect a 72% annualized "yield."
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