Should you believe the S&P 500 Targets for 2025?

Do you expect a correction in U.S. markets or do we expect a strong rally? We all have witnessed in the past that the yearly outlook of most of the Global banks, Broking houses and analysts fails to give a correct projection and in most cases, it is just the opposite of what they predict.  Should you be allocating more to U.S. funds and ETFs or should you look to other countries for investments?  It is not about Trump and his economic policies but only about the analysis of 2024 and the base it had created for U.S. economic prosperity and stock market valuation.

The U.S. economy faces significant income inequality. S&P 500 alone is not able to project to correct guidance for the outlook. The technology sector, especially the "Magnificent Seven" stocks (Apple, Amazon, Alphabet, Microsoft, Meta, Tesla, and Nvidia), has been a focal point. Despite concerns over valuations, these stocks are expected to continue performing well, albeit possibly not as dramatically as in 2023. However, the energy sector is also noted for having the highest percentage of analyst "buy" ratings, suggesting potential for outperformance.

The U.S. markets show signs of exuberance, with stock prices at all-time highs and valuation metrics reaching unsustainable levels. Despite multiple rate hikes earlier, the markets seem to have priced in interest rate cuts for the coming year, fuelling further optimism. The U.S. is facing challenges with a national debt of $36 trillion and a GDP deficit nearing 7%.

Many stocks, particularly the "Magnificent Seven," are trading at elevated levels, raising questions about their long-term sustainability. Stock markets worldwide are hitting record highs, suggesting potential overheating that could result in a sharp correction. In the U.S., inflation has risen in recent months, causing alarm. Both consumer and wholesale prices, which had shown steady improvement last spring, have recently picked up, delivering an unwelcome surprise.

 Trump Economics and Cost of Living

Studies from Trump's first term show that tariffs imposed on goods like steel, aluminium, and numerous products from China led to increased costs for U.S. importers, which were often passed on to consumers. For example, research indicated that these tariffs increased prices for consumers by between $500 to $1,700 per household annually, depending on the scope of the study and what factors were considered.

We all are aggressively waiting for U.S rate cuts to happen but do we measure how much the benefit would be for those rates cuts? Studies from Trump's first term show that tariffs imposed on goods like steel, aluminium, and numerous products from China led to increased costs for U.S. importers, which were often passed on to consumers. For example, research indicated that these tariffs increased prices for consumers by between $500 to $1,700 per household annually, depending on the scope of the study and what factors were considered

Proposed Tariff hikes Impact

Trump has proposed a 10% to 20% tariff on all U.S. imports, alongside significantly higher tariffs on goods from China (60% to 100%) and Mexico and Canada (25%). If implemented, these tariffs are estimated to raise consumer prices further.

• An average household could see an annual cost increase of around $1,500 due to a 10% tariff on all imports, with middle-income families potentially facing a $1,700 increase.
• A 25% tariff on Mexican and Canadian car parts could add about $2,100 to the cost of each U.S.-assembled vehicle, while cars produced in Mexico or Canada might cost up to $10,000 more. Tariffs could cause a typical family's annual grocery budget to increase by almost $200 in 2025, representing over a 3% rise in costs.

The expectation of a 10% increase in earnings for S&P 500 companies in 2024, following a 3% rise in 2023, has fuelled buyback activities. Companies with excess cash from these earnings are more inclined to repurchase shares, especially when they believe their stock is undervalued. As the stock market is currently overvalued the same is not expected to happen in 2025. This buyback will come in place only when the market will fall down. 

The job market shows signs of deterioration, with the hiring rate falling to 3.3%, the lowest since the 2020 pandemic. This rate is now below both the pre-pandemic average and levels seen during the 2001 recession. Despite this, U.S. labour productivity since the 2008-09 financial crisis has grown by 30%, significantly outpacing the Eurozone and the UK, which has implications for global economic hierarchies.

The housing market has seen substantial price increases, with the average home price in the U.S. up over 50% in the last five years, more than double the increase in wages. This has led to the least affordable housing market in history, highlighting a significant gap between housing costs and income levels.

S&P 500 valuations and Trumps impact Outlook

The forward price-to-earnings (P/E) ratio for the S&P 500 has risen to around 20, suggesting that stocks are currently overvalued relative to historical norms. This high valuation, coupled with optimistic earnings estimates, indicates the potential for market corrections if these expectations aren't met.  The P/E ratio on the S&P 500 has moved up to 26, with a multiple expansion of 17% in 2024, which is significantly above the average since 1989.

Buyback Saviour for S&P 500

The S&P 500 rally could sustain based on the buy back of shares. U.S. companies are on track to buy back a record amount in 2024. Projections suggest that buybacks could reach or exceed $1.1 trillion, showing a substantial increase from previous years, with some estimates even pointing towards a figure close to $1.2 trillion by the end of the year.

• Q1 2024: Buyback volume for U.S. companies totaled $238.6 billion, marking a 4.1% increase from the same quarter a year earlier. This quarter saw a recovery in buyback activity after a period of stagnation, with companies like Apple, Alphabet, Meta Platforms, NVIDIA, and Wells Fargo leading the charge.
• Q2 2024: Buybacks jumped by 35% compared to the first quarter, reaching $236 billion, which was near the all-time record. This surge was largely driven by the top 20 companies in the S&P 500, which accounted for 52% of all repurchases, surpassing long-term averages in terms of concentration.

 Conclusions:

Trump's economic policies will bring up inflation for the U.S. and that can't be ignored.  The stability of the job market at the cost of higher inflation is a tricky path and most difficult to travel.  The benefits of Tariff hikes and job creation will be nullified by the high cost of living.

Overall, while the U.S. economy shows robust growth in productivity and certain sectors, it faces challenges in labour market dynamics, housing affordability, and fiscal sustainability. The balance of these factors will continue to shape the economic landscape in the coming years. Don’t think it is only Trump who will keep the Tariff hikes. There's a risk of retaliatory tariffs from affected countries, which could affect U.S. exports, leading to job losses in export-dependent industries and further economic strain.  Keeping an allocation in the U.S. is important since its deglobalization hiccups are an opportunity for creating long-term wealth for investors' portfolios. At the same time, profit booking cannot be ignored and rebalancing should be continued.