Last week when stocks were rising with the S&P 500 closing at its fifth straight record high, investors seemed unfazed by a Fed taper later this year.  After yesterday’s FOMC minutes and three sharp down days in a row, the market now worries over a Fed taper.  Markets always find a way to make you scratch your head.

Breadth has deteriorated this month, with investors aggressively selling cyclical sectors that are dependent on a strong economy.  While the S&P 500 is down about 3% from its all-time high, the average stock in the S&P 1500 index (a mix of large, mid, and small caps) is 16% from its 52-week high.  Clearly there is turbulence below the surface of the market averages.

The extremely strong performance of economic data relative to expectations since the middle of last year has worn off.  U.S. data is actually coming in below estimates, while many major economies such as China and the Eurozone are also slowing.  In emerging markets, economic surprises are cooling off but remain firmly in positive territory.  This week the market is digesting the ‘peak everything’ story where forecasts may be downgraded from this point forward.  It appears to us that the ‘early cycle’ of this economic recovery and bull market may now transition to the next phase, or ‘mid-cycle.’

Earnings are exploding and rising faster than share prices.  The 2021 consensus earnings estimate for the S&P 500 is now $198.77, which is probably too low because so many companies have raised guidance (source:  FactSet).  If earnings reach $220 for 2021, the index’s valuation is about 20x (down from 23x in spring).

If longer-term economic growth going forward is higher than average due to economic recovery, inventory build, productivity, and other factors, S&P 500 earnings could hit $300 by 2025.  Apply 20x to that number equals 6000 on the S&P 500 in 2025, about 35% higher than current levels.  Maybe that is a bit optimistic, but today’s market sure doesn’t look like a bubble to us.