Takeaway #1: We have lifted our 12-month forward S&P 500 price target to 7,900, which represents a 7.7% gain from the May 7th close.
In adjusting our forecast, we are focusing on our valuation/EPS model, which gives us the best way to bake in a two-speed economy and earnings backdrop.
For our P/E calculation – we bake in macro assumptions for 1Q27 that are more onerous than consensus – 3.3% CPI and 4.5% 10-year yields; this takes the implied trailing P/E down a bit from the highs of the past year to around 24x.
Meanwhile, for earnings – we take the bottom up consensus, trailing 4Q, for 1Q27, and lower it by 5%, taking the expected growth rate yr/yr down from 18% to 12%. How did we get to that 5%? We took the S&P 500's consensus net income forecast, dividing it into an AI basket and ex AI basket.
"We don't think the path will be linear, and that pullbacks are likely. That's a nuanced view, not a bearish one."
Lori Calvasina, Head of U.S. Equity Strategy, RBC Capital Markets
We left the consensus forecast for the AI basket unchanged – the forecasted growth rate of that cohort is 28% by the way, the fast lane in our two speed earnings back drop. For the S&P 500 ex that AI basket, which we think is more at risk from Middle East impacts, we took the consensus forecast for 1Q27 and lowered it by 7.5%. That's the slow lane, as our adjusted forecast is anticipated growth of 6% in that cohort.
The end result of all that math: a fair value estimate for the S&P 500 of 7,929, which we round to 7900 to set our new target.
We do see some upside risk to our view – the median and average of the five models we normally use to set the target is around 8,100. The median output comes from our sentiment model based on AAII net bulls. Net bulls have been rebounding, but are still a little below average. When net bulls are between average and one standard deviation below average, the S&P 500 typically moves up 10.8% over the next 12 months.
Two of our other models are looking for even higher returns in the 13-14% range.
Note that we don't think the path will be linear, and that pullbacks are likely. That's a nuanced view, not a bearish one, as we continue to have one of the higher price targets on the Street. But as long as recession fears are held at bay, we expected pullbacks to be no worse than 5-10%.
