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S&P 500 target of 3200, on EPS +7% in '19

We are revising our 2018 year-end price target for the S&P 500 to 2875, down from 3150. While 2018 EPS has continued to be revised up ($163.5 is our new estimate), the P/E has declined much more than we expected on increased trade risks, RoW growth concerns, higher real interest rates, and concerns about the growth cycle. We had expected weakness in September and October (link), but the magnitude of the pullback and volatility spike was larger than we expected, in part due to the synchronized risk flare-up (Fed, trade, growth concerns).

The implied return to the end of the year would be 5.5% assuming 2875 for the S&P 500. The historical median return for the last two months of the calendar year is 3.8%. Given the market volatility since September, where the equity market will finish is difficult to call. The 2875 level also implies a forward P/E that is 16.2x based on consensus, which is below the average levels in the multiple since 2016 and pricing some of the risks in our view.

Our 2019 base case for the S&P 500 is 3200, on EPS growth of 7.2% and multiple expansion of 0.7x. Our price target is based on 2019 EPS of $175 and a trailing P/E of 18.3x, and an implied forward P/E of 16.6x based on typical consensus expected growth of ~10%. In our EPS and multiple assumptions, we assume the move from 10% to 25% tariffs on $200bn of China imports in 2019, but no further escalation in trade tensions. We run through key scenarios and related impacts below. Overall, we are forecasting slightly above-average EPS growth for the S&P 500; this would be typical at this phase of an earnings cycle when earnings continue to move above trend, but grow at a slower pace.

As we discuss below, the multiple is key for market returns, and after a big derating in 2018, we are calling for some multiple expansion in 2019 as quite a bit is priced into US equities as it relates to risk. We lay out our rationale on the multiple:

Following large de-ratings, the multiple recoups an average of about 30% of the prior year's de-rating. This would imply a 0.7x increase in the case of the over 2x de-rating in 2018, which is in line with our forecast.

Our P/E model, using forecasts of macro variables, would imply a much smaller decline in valuations from higher rates and macro vol (-0.3x) as well as earnings going further above trend later cycle (-0.6x). Higher dividend payouts would be a positive offset for the P/E (+0.1x), assuming dividend growth of 11% in 2019. A slower pace of growth in UST issuance (link) should also help.

Figure 5: S&P 500 EPS forecast and price target

	Current /
	LTM	2016	2017	2018E	2019E	2020E
Price	$2,726	$2,239	$2,674	$2,875	$3,200	-
% yoy		9.5%	19.4%	7.5%	11.3%	-
% chg vs current			-1.9%	5.5%	17.4%	-
Earnings per share	$155.0	$118.1	$132.0	$163.5	$175	$183
% growth		0.5%	11.8%	23.9%	7.2%	4.3%
P/E multiple (trailing)	17.6x	19.0x	20.3x	17.6x	18.3x
% change			6.8%	-13.2%	3.9%

Source: IBES, FactSet, UBS

3200 price target implies 18.3x

2019E EPS and 17.5x 2020E EPS

After the big de-rating in 2018, we expect the P/E to increase 0.7x in 2019E, in line with the average recouping of prior year deratings. This combined with EPS growth of 7.2% implies a total return of 11% in 2019 based on our 2018 price target of 2875.

US Equity Strategy 13 November 2018

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S&P EPS forecast +7% in 2019 to $175, +4.3% in 2020

For 2019, we forecast EPS growth of 7.2%, driven by US real GDP growth of 2.4% and global growth of 3.6%, based on our economists' forecasts for 2019 (link). We see some headwinds to earnings from higher labor costs, past USD strength, and slowing growth. We assume a 1.4% tailwind from stock buybacks. While consensus EPS of $177 includes some margin expansion, we expect 2019 margins to be flattish as the rate of change in GDP growth (2nd derivative) declines. We are also below consensus for Energy and Financials based on our model.

Figure 6: S&P 500 EPS estimate for 2019, contribution by key variables

175										1.53	2.29	$175
			1.33	(0.40)	0.30	(0.16)	(1.19)	0.93	0.93
170
165	$163.5	6.17
160				S&P 500 ex. Fin, RE, Energy
155
150
145
140
	2018E	US real	RoW GDP	USTWB y/y	IPP+Equip /	US real	Unit	Nonfarm	Energy NI	Financials NI	Buyback	2019E
		GDP	vs. US		Structures	GDP rate	labor	prod.	growth	growth	tailwind
						of change	costs
Beta		3.82	1.67	-0.24	0.29	1.78	-0.75	1.45	-	-	-
Assumption		2.4%	1.2%	2.4%	1.5%	-0.1%	2.4%	1.0%	11.0%	5.3%	1.4%

Source: UBS estimates

We forecast continuing yet slowing EPS growth of 4.3% in 2020. A deceleration in GDP growth should continue to limit the potential for margin expansion, while higher labor costs as the rate of growth slows will be an offset. With S&P 500 EPS forecast to be ~13% above trend levels at the end of 2019, we would expect EPS growth to slow to rates below the 6% trend level.

Figure 7: S&P 500 EPS estimate for 2020, contribution by key variables

185		(0.02)	(0.15)				2.28	$183
	1.60			(1.23)
180		0.00			0.49	(0.13)	0.40
$175	4.21
175
170		S&P 500 ex. Fin, RE, Energy
165
160
155
150

2019E	US real	RoW GDP	USTWB y/y	IPP+Equip /	US real	Unit	Nonfarm	Energy NI	Financials NI	Buyback	2020E
	GDP	vs. US		Structures	GDP rate	labor	prod.	growth	growth	tailwind
					of change	costs
Beta	3.82	1.67	-0.24	0.29	1.78	-0.75	1.45	-	-	-
Assumption	2.0%	1.8%	0.0%	-0.1%	-0.2%	3.1%	0.6%	-1.5%	1.3%	1.3%

Source: UBS estimates

We expect dividend growth to outpace earnings growth in 2019. With profits up 20%+ in 2018 but dividends growing less than 10% for the S&P 500, we expect payout ratios to rise after the drop this year. Thus we expect dividend growth of 11% on EPS growth of 7% in 2019 as firms normalize dividend payouts. Additionally, no tax on repatriation of foreign profits means that multinationals can sustain a higher level of dividends.

US Equity Strategy 13 November 2018

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