It probably hasn’t felt like it to the average stock market investor, but the last 2 years have been pretty darn good. From the chart above we see that the S&P 500 has rallied 25% in the last 24 months, above the historical average for the equity market.
After such a run, it feels right to take some profits off the table. However, when you look at the current forward P/E on the S&P, it’s easy to wonder if we have more to run. Right now earnings estimates for the index are north of $80 on an operating basis for 2006, giving the market a P/E of around 15. That hardly screams “sell” even if energy and housing stocks have contributed a large amount of those earnings gains.
So, what do we do from here? Well, the S&P is retracing the recent move up and will soon test the breakout of 1,220 it made last month. If that level holds, the market might be okay despite a very impressive move in the last 24 months.
How high can we go? Well, I wouldn’t be overly bullish. I doubt we would see a P/E of more than 16 in this market environment, which indicates upside to 1,300-1325 area on the S&P, if all goes well. Hardly huge returns from here. All in all, it’s likely prudent to be fairly defensive here, given upside potential is likely only in the single digits on the major market indices.