A version of this post first appeared on TKer.co
Wall Street strategists are almost unanimously upbeat about the earnings outlook.
Their estimates for S&P 500 (^GSPC) earnings in 2026 range from $300 to $320 per share, implying 11% to 19% year-over-year growth from this year’s expected level.
However, strategists are divided on valuations – in particular, the direction of the forward price-to-earnings (P/E) ratio as it nears five-year highs.
Some argue that the high forward P/E is justified and sustainable, which should help the market achieve above-average returns in 2026.
Others argue that the high P/E is a headwind to the market, limiting returns as it potentially gravitates lower toward the long-term average.
People who believe that valuations tend to revert to historical means (a phenomenon that has been disputed) lean toward this more conservative view. Maybe this time they will be proven right.
While the P/E ratio can help us understand whether prices look cheap or expensive relative to history, the evidence shows that the level of the forward P/E ratio doesn’t actually say anything about what the stock market will do in a year’s time.
In their Outlook to 2025 report, Schwab’s Liz Ann Sonders and Kevin Gordon shared this fantastic illustration (which TKer subscribers have seen before). It shows the one-year return of the S&P 500 for various forward P/E levels since 1958.
“You can see that the relationship is very weak -0.12 – essentially non-significant,” Sonders and Gordon wrote. “It underscores the important market truth that valuation is a horrible market timing tool (as if there was a good timing tool).”
“The rating says … nothing,” Schwab analysts wrote. (Source: Schwab)
The graph is chaotic. Yes, there are periods when a forward P/E of 22 times preceded negative returns. But it is also a level that has preceded very positive returns several times.
First, there are many more points on the right side of the y-axis in the graph above than there are on the left side, a reminder that the stock market usually goes up. This is true even for periods of high P/E ratios.
I would say this is because earnings and earnings expectations are usually rising, and earnings are the most important long-term driver of prices. Indeed, much of the stock market’s rally this year can be explained by the upward trend in earnings expectations, even as P/E ratios flatten.
Second, falling valuations doesn’t necessarily mean prices have to fall. Stocks can rise as valuations fall, as long as earnings rise faster than prices. More Here, Hereand Here.