Before delving into the drivers of our 2025 forecast, it is important to address the implications for the S&P 500 finishing up at 23%. Equity valuations are not cheap, but the earnings outlook and rate environment seem favorable. That said, the valuations at this point make big moves in gains more challenging. To best illustrate our outlook, we bring in Charles Dickens “A Tale of Two Cities” as a backdrop of our bifurcated 2025 forecast between the first half of the year, and the second half. Montecito Capital Management forecasts a relatively strong first half of the year for stocks, then expect the S&P 500’s fortunes to fade later in the year. Looking at the history of back-to-back 20% yearly gains with five precedents since 1871, stocks are more likely to have delivered superior returns early on. In fact, in all five precedents stocks do worse in the second half of the third year after two 20%+ return winning years. Final point, we anticipate a market correction (-10%) at some point during the year, albeit brief in duration.
Since this is a full year outlook, we turn to the overall annual historical events to offer further guidance. Since 1950, there have been eight times the S&P 500 gains over 20% for two years in a row. In six of those eight times, the third year saw positive gains, which shows a 75% historical probability of an overall 12% average return. It is my view that should interest rates remain well-behaved, and inflation does not resurge, then we should see a positive return for equities in 2025. For perspective, as of December 20, 2024, there are 12,168 ratings on stocks that make up the S&P 500. Of these 12,168 ratings, 54% are “Buy” ratings, 40.1% are “Hold” ratings, and just 5.1% are “Sell” ratings.
Turning to the return outlook, the current starting point in terms of valuations is higher than normal, making outsized returns harder to come by. Nonetheless, Wall Street strategists expect the S&P 500 to rise by low double digits in 2025, with targets ranging from 6,400 to 7,007; this implies returns between +5% and +15% from current levels. The two leading Investment firms, Goldman Sachs and rival Morgan Stanley, are both on record with predictions that the S&P will end next year at 6,500. The average estimate for year-end 2025 is similar, standing at 6,472, marking an expected 10% gain.
Charles Schwab analyzed market data between 1933-2015, and found that, in general, the first year of the presidential term returned 6.7% on average. From a different viewpoint, the S&P 500 returned 14.1% annually during Trump’s first presidency, marking its best performance under any president except Bill Clinton. But, the S&P 500 had a forward P/E multiple of about 17x when Trump first became president in 2017, and the multiple generally stayed below 18x until the pandemic. That means Trump is set to inherit a much more expensive stock market this time, with a forward P/E of 21.6x.
In light of elevated prevailing valuations and policy uncertainties, our outlook on U.S. equities remains moderately optimistic. This view is underpinned by anticipated S&P 500 earnings growth of 10%-11%, a healthy economy, potential Federal Reserve interest rate reductions, easing inflationary pressures, and favorable operating leverage. While our $272 earnings-per-share (EPS) projection for the S&P 500 aligns closely with Wall Street’s 2025 estimate, our anticipated return is more conservative with a lower P/E multiple of 23x, which is below Wall Street’s loftier P/E of 24x. We set our 2025 target for the S&P 500 at 6,255, suggesting a modest return of approximately +6.4% for the upcoming year.
FORWARD LOOKING, 2025 U.S. ECONOMY
In our most likely scenario, we anticipate that gradually looser monetary and/or fiscal policy will drive growth. While inflationary pressures persist, they remain manageable. Like our 2024 mantra, we see the investment landscape as a Glass Still Half Full. Relatively strong U.S. productivity, respectable earnings growth, stable employment and interest rate cuts – this gives us confidence that the economic growth cycle is not over. A big part of the stock market rally in 2024 was based on the premise that the central bank would continue loosening monetary conditions over several quarters, which occurred in the form of three rate cuts totaling 1.00%. In 2025, the expectations are lower, with only two rate cuts totaling 0.50%.
- Fundamentals remain supportive, with third-quarter corporate earnings beating expectations. In aggregate, third-quarter S&P 500 earnings increased by 8.7% on 5.4% revenue growth.
- Third quarter GDP, a key economic indicator, increased at an upwardly revised 3.1% annualized rate.
- NielsenIQ is projecting that global consumer spending will increase by $3.2 trillion in 2025 but expects U.S. consumer spending to moderate to a trend-like pace of 2% in 2025.
- The Dot Plot forecast shows two rate cuts in the coming year with a 2.5% core PCE inflation rate. In other words, the Fed expects inflation to be sticky for longer and is unlikely to ease interest rates in the way the markets anticipated.
We believe the fundamental drivers of productivity will be higher than the average GDP consensus expectation of 1.9%, with an upward surprise at 2.5%. The forecast indicates that unemployment will likely remain below standard levels for 2025, as some sectors will continue to recruit. However, given there is a political regime change, we anticipate larger deficits, more tariffs, geopolitical tensions, a complicated energy transition, and persistent inflation in the economy.
For more information, please contact Montecito Capital Management, 805-965-7955
