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Why Does the S&P Keep Going Up?

Despite the threat of a nuclear war, events in Washington, and a proliferation of more truly frightening headlines than ever before, the stock market has continued to go up. Why? While stocks breaking record highs repeatedly for months may seem at odds with all the bad news, rarely has the outlook for the economy been so bright. It is the best and worst of times.

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The International Monetary Fund, in its latest World Economic Outlook, revised its July estimate for world growth higher, to 3.7%. That’s way up from 2016, when the world economy grew by 3.2%. In July, the IMF estimated global GDP for 2017 would jump to 3.5%, and then to 3.6% in 2018. The latest revision bumped up the expected growth of the world economy to 3.6% in 2017 and 3.7% in 2018. A good world economy is good for everyone, including the U.S.

The Wall Street Journal asks more than 60 economists for their growth forecasts every month. In early October, the consensus forecast of those surveyed was for the US to average a 2.5% growth rate for the five quarters through September 30, 2018.The expected growth rate of 2.5% is much higher than the average GDP growth rate of just 2.1% during the first seven years of the economic expansion, which started in March 2009.

If the consensus forecast is right, then the U.S. is about to grow much faster than it has so far in this expansion. Economic growth drives earnings and earnings drive stock prices, so this is very good news for stocks. The average annual earnings growth rate over the decades on the Standard & Poor’s 500
stock index is 7.3%, but earnings are expected to grow by 12% in 2017 and 11% in 2018. That would be a surge in profit growth. Again, since earnings drive stocks, this is music to the ears of stock investors.

Adding to the good economic news, the Senate passed a budget resolution, taking a step toward enacting a massive one and a half trillion dollar tax cut.
Your current tax bill for 2017 could decline, and lower taxes would boost consumer spending, savings, and business activity.

Statistically, as this bull market grows older, the likelihood of a bear market a drop of 20% or more increases. As is always true, a correction of 10% or 15% is possible at any time, just on a change in sentiment or some bad unexpected world event. But the economy shows no signs of coming undone. Fundamental economic conditions that have accompanied bear markets in the past are not present now. To the contrary, inflation is tame, job growth has been strong, real growth in wages and disposable personal income are at record levels, and precursors of recessions in the past are nowhere to be found now.

Despite the value of the S&P 500 tripling since it bottomed in March 2009 and the flood of good economic fundamentals, irrational exuberance is not an issue.
Investors have not bid stock prices beyond their historical valuation range.

The average price of a stock in the S&P 500 trades at 19.9 times its trailing 12 month earnings and at 17.4 times the consensus bottomup forecast for 2018 earnings, according to consensus estimates. The price of the S&P 500, which has hit record highs repeatedly for months, broke another record last week, and the Dow Jones Industrial Average hit the 23,000 mark for the first time ever.

In the epochal opening sentence of A Tale of Two Cities, Charles Dickens described the years of The French Revolution as the best and worst of times, but the world may always seem to be in such turbulence and yet it keeps turning. Despite the frightening headlines and all that’s going wrong, the economic outlook is bright and the bull market could head much higher and run much longer.

Watch the full video on Prosperity's YouTube Channel

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Market DataBank: 3Q 2019

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