Every year, strategists at major banks and investment firms publish where they think the S&P 500 will finish the year. The numbers make headlines, get revised when markets move, and are quoted as if they were predictions of the future. They are better understood as scenarios built on a simple formula.
The basic formula
Most index targets start with two inputs:
- Earnings per share (EPS) for the index, usually a forecast for the following year.
- A price-to-earnings multiple, the price investors will be willing to pay for each dollar of those earnings.
Multiply the two and you get a target. If a strategist expects index EPS of 250 and assumes a forward P/E of 20, the target is 5,000. Everything else in a strategy report is essentially an argument for why those two numbers are reasonable.
Why the multiple is the weak link
Earnings forecasts for the index as a whole are built bottom-up from analysts’ estimates for each company, and while they are often too optimistic, they are anchored in reported results. The multiple is harder. It depends on interest rates, investor sentiment, and the mix of companies in the index, none of which can be forecast reliably a year out.
Small changes in the multiple matter a great deal. Using the example above, moving the assumed P/E from 20 to 18 or 22 changes the target by 10% in either direction, which is roughly the size of an average year’s return. That is why two strategists who agree on earnings can publish very different targets.
The track record
Studies of strategist forecasts have repeatedly found that year-end targets are poor predictors of actual index levels. Forecasts tend to cluster near a modest positive return, while real annual returns are widely dispersed, including large gains and sharp losses. Strategists also tend to revise targets in the direction the market has already moved, which makes them more of a description than a prediction.
None of this means strategists are not skilled. It means that one-year market returns are dominated by events and shifts in sentiment that no one can know in advance.
What is actually useful in a forecast
The number at the top of the report is the least informative part. The valuable parts are the reasoning:
- Earnings assumptions: which sectors are expected to drive profit growth, and what margins are assumed.
- Macro assumptions: expectations for growth, inflation, and interest rates.
- Risk scenarios: bull and bear cases show what the strategist thinks could go wrong or right.
- Positioning views: sector and style preferences reveal where the analyst sees relative value.
Comparing the assumptions across several firms tells you where the consensus sits, which is useful because markets tend to move when reality diverges from consensus.
A healthier way to use targets
Treat forecasts as a map of expectations, not a destination. Ask what the forecast assumes, whether you find those assumptions plausible, and what data over the coming months would confirm or contradict them. For long-term investors, the historical evidence points toward a diversified plan that does not depend on guessing where the index will be on December 31.
To understand the valuation half of the formula, read our guide on how to read the P/E ratio.
