On best revisions for GDP and earnings in 2018 after Tax reform, the S&P is now less expensive than before, at just 57% above historical average…

In this brief note, we wanted to update our value indicator for the S&P, after the steep consensus upgrades to US earnings and US GDP that followed the US tax reform.

We assess how big of an improvement should we see after the reform, assuming a GDP growth of 3.40% in 2018, which is the average of the 10 highest analysts’ forecasts surveyed by Bloomberg, and assuming a 26% jump in earnings in 2018, again at the top end of surveys. We conclude that, against such most generous estimates, the ‘Peak PEG’ ratio for the S&P improved by almost 10%, or, rephrased, it is almost 10% off peak.

It follows that the S&P is now above historical averages by a mere 57%.

The Peak PEG ratio, using Peak Earnings and Trend Growth

The ‘Peak PEG’ ratio is a variation of the Shiller P/E and the Hussman P/E indicators. It measures the price-earnings to growth ratio (PEG ratio) not for a single stock but for the market as a whole. The ‘Peak PEG ratio’ is a price to peak-earnings multiple, adjusted for long-run trend growth. It considers the highest (rather than average) earnings over the previous 10 years (top 2 quarters on the last 40) and then divides for growth potential. It uses top earnings so to conservatively assume the best profit generation capability for stocks in a decade to persist, thus defusing a common critic to the Shiller P/E. It uses GDP trend growth so to proxy earnings growth potential, which is highly correlated to it over time.

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