Previous Prediction: The S&P 500 will be at 5,500 at the end of 2024.
The S&P 500 began 2024 a little above 4,700. A year ago, the consensus outlook was extremely pessimistic in that it called for a flat market. Generally, the large Wall Street banks are fairly optimistic and project that the market will grow about 10%. A consensus forecast that projects a flat market is highly unusual.
Our projection assumed that valuations would stay the same while earnings continued to grow, since we did not anticipate an economic recession. We were right about the direction of earnings. Earnings grew approximately 15% in 2024. What we did not anticipate was that the valuation that investors would pay for earnings would continue to increase. The market finished the year at 22 times forward earnings after beginning the year at 20 times earnings, and the S&P 500 ended the year around 6,000. So, our forecast was better than the Wall Street banks but still underestimated the strength of stock market returns.
Previous Prediction: There will not be a recession in 2024, and the Federal Reserve will cut interest rates as inflation falls, successfully engineering a soft landing.
The Federal Reserve cut interest rates by 1% in 2024. In doing so, they said that there was little risk of accelerating inflation, and they could begin to cut interest rates. They did not cut rates as much as investors expected due to the stronger than expected economy. The economy didn’t even come close to a recession in 2024. This was a textbook soft landing, only the second in the last thirty years.
2025 S&P 500 Outlook
For 2025, the S&P 500 is projected to earn $275. Historically, these estimates are a little inflated. I’m assuming that earnings end up a little below the current estimate so I’m using $260 as my 2025 earnings target. At a recent peak of approximately 6,100, the S&P 500 is trading at 23.5 times the 2025 earnings.
Trying to figure out where valuations will go is next to impossible. Financial fundamentals like interest rates and currency exchange are big components of valuation, but we also have to deal with intangible, less predictable factors like geo-politics and investor sentiment. The safest prediction is to assume that valuations stay where they are, recognizing that they could go higher or lower.
As the market trades based on the next twelve months’ earnings estimates, determining a year-end target for 2025 requires projecting 2026 earnings. The further out we project, the less reliable predictions become so our prediction is just an educated guess. The current consensus estimate for 2026 earnings is $308. Typically, those estimates come down as they become more current.
If we shave 3% off 2026 earnings estimates, we project that earnings will end up at $298. Assuming a multiple of 23.5 leads us to a year end price target of 7,000 for the S&P 500. This projection implies a gain of over 15% for the year 2025.
This projection could be conservative. Generally, as long as the economy is not in a recession, valuations tend to increase. It is highly unlikely that we experience a recession in 2025. If the economy continues to grow as expected, valuations could continue their trend of slowly increasing.
Financial fundamentals broadly dictate the direction of the markets. How we get there is another question entirely. The first year of a new presidential administration is often noisier than most. We should expect greater volatility than what we’ve seen in the last couple of years. There is a greater range of outcomes for tax, trade and foreign policy.
We can look to President Trump’s first term to get a sense of how a second term could play out. Reuters looked back on the first Trump administration in 2020:
Hours after Trump’s unexpected win on Nov. 8, 2016, expectations of massive tax cuts and financial deregulation kicked off a stock rally that saw the S&P 500 surge 5% in a month. Wall Street continued its path higher through a trade war and impeachment, going on to new record highs following a deep slump caused by the coronavirus pandemic that continues to cripple the global economy.
From 2016 to 2020, the market was up 10.6% per year. This is right in line with the historic average return for stocks. Markets tend to act as guardrails against too bold or risky policy moves. I suspect that the Trump administration will make bold moves then walk back the policies to which the market responds most negatively.
Economic Outlook
The economic outlook under Trump depends on several key policy initiatives and their anticipated impacts:
Deregulation of technology, energy, and financial sectors: This approach is anticipated to stimulate growth within these sectors by reducing regulatory burdens.
Upward pressure on interest rates: Tax cuts, deficit spending, and tariff increases will likely increase inflation expectations so I don’t expect interest rates will fall as much as previously expected. Interest rates could move higher depending on how much the increase in tariffs impacts the supply chain.
The rate of inflation is decreasing: Higher inflation is hitting housing prices. We are starting to see this reflected in lower rent prices. New lease agreements show deflation relative to last year. This will slowly lead to a lower overall rate of inflation.
The combination of these factors under Trumpism suggests an economic environment characterized by deregulation, higher interest rates, and a gradual decline in inflation due to adjustments in housing costs. This outlook also suggests the potential for sustained economic strength, thereby reducing the need for further interest rate cuts. On balance, the macro-economic environment is broadly favorable for stocks over the next year.
