US equities have risen faster than most people expected so far this year, and while some people are concerned that this could be the lead up to a market correction, Citi analyst Tobias M Levkovich argues that the gains are supported stronger earnings, pushing his S&P 500 (INDEXSP:.INX) 2014 year-end estimate from 1975 to 2000 based on $118.20 EPS (up from the previous $117.75 estimate) and setting a mid-2015 estimate of 2050.

S&P 500 earnings beat Citi estimates despite difficult first quarter

“Earnings have beaten estimates, at least in 1Q14 where even a weather-induced GDP decline did not end up crushing the bottom line,” writes Levkovich. “With share prices higher and better EPS, one has to rethink the outlook especially as mid-year approaches.”

One of the main criticisms of last year’s equity bull market is that it outpaced corporate earnings, but Levkovich argues that 2013 stock prices were benefitting from 2011-2012 earnings growth that had yet to be priced in. From that point of view, the multiples had actually been compressed in the previous two years on negative sentiment, caught up in 2013, and are now moving at a reasonable pace for a recovering economy.

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CAPE not useful for short-term investments, says Levkovich

Levkovich acknowledges that cyclically adjusted PEs (CAPE) are high right now, but he doesn’t think that people should focus on that. His preferred metric, the normalized earnings yield gap, is 1.4 standard deviations below average, which historically gives a 92% chance of market gains in the next year.

S&P 500 v cape 5 yr 0614

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While he doesn’t dismiss CAPE as being a useful way to value stocks, Levkovich points out that it doesn’t correlate very strongly with one-year gains. The further you push out your investment horizon the better CAPE performs, but of course not everyone is willing to wait that long.

“Few investors have the luxury to wait five years to perform before their clients probably take their money back. Thus, one has to string together a year-by-year track record and cannot look out too far anymore,” he writes.

Most value investors would probably respond that people shouldn’t be looking focused on single year returns, but Levkovich has a fair point. The rise of low cost, passive ETFs has put many active managers on the defensive. If they don’t show consistent returns, clients may wonder why they’re paying the higher fees.