A Look At The Consensus View
The opening couple of weeks of a new year are filled with seasonal quirks, rebalancing, and intermittent flow dynamics—much of which is constructive, hence why we get the January effect, but it's not a period to draw much inference from. On the data front, it’s been quiet coming out of the holidays other than last week’s ISM manufacturing report, which ticked modestly higher but was still below the 50 level. Things will pick up this week, highlighted by the jobs report at the end of the week. Then, as we move into the second half of January, we’ll get into earnings season, where guidance will garner as much, if not more, attention than the actual earnings numbers.
But in the meantime, humor me as I think out loud about where the consensus view is on equities and how my expectation differs. Going into 2024, the average Wall St. strategist target on the S&P 500 for year-end was 4,860, with a range as low as 4,200 and as high as 5,400. The average of the year-end targets was roughly 1,225 points or 25% below where the S&P 500 closed out the year (6,086).
How could some of the sharpest minds in this craft we call investing be so far off the mark? Well, for starters, predicting the future is no easy task. But let's try a simpler and more fundamentally driven framework. Including Q4 numbers, which start to be reported this month, earnings growth for 2024 is estimated to come in at around 10%, marking the fourth consecutive year of EPS growth.
As the theory goes, stock prices track earnings, so earnings growth of roughly 10% explains about half of the 23% gain experienced in the S&P 500 in 2024. The rest was made up of multiple expansion. Using trailing earnings (because trailing earnings are what are actually reported rather than forward earnings, which are estimates), the S&P 500 started the year trading with a P/E multiple of approximately 24x and ended the year near 30x. In hindsight, what strategists underestimated was the degree to which investors would be willing to pay higher and higher prices for stocks. If multiples remained constant, the S&P 500 return for 2024 would have been about half what it gained, but instead, investors were willing to pay a 25% higher multiple at year-end 2024 than where they started the year. This proves how unpredictable and difficult it is to model humor behavior. Modeling earnings, dividends, growth rates, pricing power, profit margins…is not nearly as tricky as the emotions of fear and greed.
Helping to fuel investor willingness to keep buying at any price last year was the constructive development of several other forces: the recession scare never came to fruition, the A.I. investment cycle fueled a narrative of significant productivity enhancement, the Fed was cutting interest rates in an effort to ease monetary policy, the fiscal spigots continued to flow, and a market-friendly election outcome transpired in November. This list is by no means exhaustive, but at the end of the day, the bear case was repeatedly debunked in the last couple of years, and the bull case gained more and more viability. This forced a lot of underinvested bears and cautious bulls to throw in the towel on whatever rationale they had for being too skeptical and jump on the bandwagon, irrespective of price and value. Oh, and don’t forget the unrelenting bid of passive flows fueled in large part by a fully employed labor market that also grew a little.
Let’s pivot to where the consensus outlook stands as we kick off 2025. According to John Authers number crunching over at Bloomberg, the average year-end target for the S&P 500 is 6,614, representing a 12% gain from the 2024 close on the S&P 500 (see the chart below). The consensus also forecasts earnings to grow almost +12% year-over-year in 2025 or more than double even the most bullish projections for nominal GDP growth.
So, what is one to make of this? For starters, we start off the year with the consensus view that stock prices will track fairly close to earnings, with both forecast to grow 12%. Based on these numbers, the P/E multiple is expected to stay constant at historically elevated levels. As has become fairly commonplace, the fate of the equity market will continue to be tied to the Mega-Cap Tech companies that not only dominate their industries but also dominate the equity market cap. The top-ten companies in the S&P 500 now comprise an eye-popping 38% of the index weight and are forecast to grow their earnings by 20% YoY in 2025. The other 490 are expected to see their earnings grow 10%, a rate of change acceleration relative to prior years but still lagging the big boys. Even when you account for the earnings power, high-profit margins, and pristine balance sheets of the Mag7, you have to acknowledge that most of them are valued handsomely for this fundamental superiority (below is a chart plotting the P/E multiples of the Mag7).
We’ve all come to learn that valuation as a stand-alone metric has become a less reliable tool in an equity market dominated by momentum, liquidity, and flows – so don’t predicate your investment strategy on it (especially without a corresponding growth reference point). Moreover, economic growth, inflation, and labor market dynamics have increased in importance as they are the key metrics that policymakers react to. And while I wish it weren’t this way, but in an era of hyper-financialization, as is the case in the U.S., variables that guide policymaker reaction functions are paramount to monitor.
This is where I see risks to the consensus view. With the U.S. dollar and interest rates pushing up near multi-decade highs, and if they stay near current levels for another 2-3 weeks, I think a meaningful tightening of financial conditions will have occurred that will negatively impact economic and earnings growth in the first half of 2025. This will put pressure on elevated valuation multiples and severely impair the ability of the S&P 500 to achieve the lofty year-end targets currently in place. To be clear, I’m talking about a growth scare and not a recession. Whether it’s a growth scare that evolves into a recession will depend on how and when policymakers (namely the Fed) react to such an event. In addition to this, the new administration, which takes office at the end of the month, will likely bring uncertainty and disruptive change. Good change or bad change? We’ll see, as there are elements of both in their agenda, but the sequence and what gets prioritized will matter.
Bottomline, I think patience and resolve are an investor’s best friend at the moment. Perhaps my highest conviction for this year is that volatility will present investors who have the tactical and strategic wherewithal opportunities to take advantage of. Such an environment will also entail periods where doing nothing but sitting back and watching is all you’re doing. Happy New Year, and good luck in 2025.
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