As we alluded to with our Earnings Update last night, the following is our second pass at 2014’s expected year-end values for the SP 500, which in turn gives us our 2014 expected returns for the SP 500 under different earnings growth (and more importantly) “market multiple” scenarios.

By multiple, I mean the particular p.e multiple assigned to either a stock or index (like the SP 500) over a particular time period.

To cut to the chase, and make it easy on readers: to have just a flat year in 2014, based on an 1,800 year-end closing value for the SP 500 for 2013 (conservative for sure), the SP 500 would grow EPS at 9% (consistent with 2013’s expected growth, and about average with 2011’s +15% and 2012’s 6%), and the SP 500 would need to trade at a 15(x) multiple, or about where the forward p.e estimate is today.

Readers are probably thinking, “that seems like a reasonable assumption”.

Here is the catch: using the above math, (and I hope my assumptions seem reasonable and appropriate to readers), to get to a 30% return in 2014 for the SP 500, all that it will take is 9% SP 500 earnings growth and a 20(x) multiple, or just a tad over 2(x) PEG, which is where the SP 500 has been trading this year.

After working through the above numbers, here is my best guess for 2014:

Year-end 2013 EPS = $110 per share

2014 EPS growth rate = 10%

Estimated 2014 year-end EPS = $121 ($110 * 1.10)

$121 * 18(x) multiple = 2,178 ending year-end value for the SP 500

Expected 2014 return: 21%

You done laughing yet ? It really doesn’t take that much in terms of p.e expansion to have another decent year in 2014. All that is required for a 20% year in 2014, is for the SP 500 earnings to grow 10% and the SP 500 market multiple to expand from 159x) to 18(x).

Europe is now stable and improving modestly (Factset had a good breakout on SP 500 large-caps with Europe exposure this weekend), Japan is certainly improving, and China looks like it is starting to throw off the deceleration and grow again. If the US, China, Japan and Europe can grow modestly and coincidentally in 2014, then 10% EPS growth on the SP 500 seems pretty reasonable.

Since, (using our forward estimate data we produce every week), the SP 500 has been hugging the 2(x) PEG metric, an SP 500 that generates 10% earnings growth in 2014, should eventually trade at 18(x) – 20(x) that multiple.

Hence the 2,178 estimated ending S&P 500 value as the world stands right now.

The flip side of the argument is that if the SP 500 grows earnings next year at below our estimate of 10% (say 6%) and the multiple stays flat with 2013’s at 15(x), we have a flat year.

My own opinion is that the real key to SP 500 multiple expansion and contraction remains interest rates and the bond markets. A too rapid rise in rates and multiple compression is likely in order. What tempers my caution around this somewhat is that I think the world’s central banks want inflation and want growth, and “normalizing” interest rates, while possibly compressing equity values (much like 1994), will eventually be positive for the US and global developed economies. The other angle to why rising rates could be a positive for the SP 500 is that during 2011, with that enormous Treasury rally we saw during the year thanks to Greece, the ECRI recession call and the Congressional debt-limit fiasco, the SP 500 multiple compressed.

The world economies want and need economic growth, i.e. stronger economic growth than we know today. I do think the world’s economies want and need a little inflation too, with the US and Japan being prime examples.

Ive always felt the “prediction” game was folly: Even Abe Lincoln told his son, when discussing his son’s career prospects, (according to the movie “Lincoln” anyway), “I’ve always found prophesizing to be a less-profitable profession”.

(Without qualifying this to any extent, one key metric is the actual 2013 ending EPS dollar figure for the SP 500, which we wont know until late March, early April, 2014. We’ll keep updating the numbers as soon as we think the estimates are reasonable and probabilistic.)

The point of all this being, that we thinks the prospect’s for a decent SP 500 return in 2014, remain favorable, if not probable.

Thanks for reading.

Trinity Asset Management, Inc. by:

Brian Gilmartin, CFA

Portfolio manager