by Justin J. Long CFP® on Jul 3, 2025 9:20:54 AM
Where We Were
2024 followed through on gains in 2023, driven higher by gradual declines in inflation expectations and gradual increases in employment, consumer spending, corporate earnings, and economic growth. Like 2023, 2024 began with Value, SMID and Foreign markets taking the lead, but overcome once again by US Large Cap Growth. Revenue and earnings growth in the Growth sectors drove performance again, while investors tried to absorb the fundamental realities of lower asset/higher margin within the Information Technology and Communication Services sectors, lamenting higher P/E ratios all year – while equities climbed even higher. Global equity benchmarks rose between 4% and 25% for the year, with the S&P 500 index taking the pole position once more. Developed Foreign equities gained 4%, Emerging markets 7%. Fixed income benchmarks struggled to stay above water last year, except higher risk, higher yielding benchmarks here at home, and foreign government bonds abroad – which were less constrained by inflation concerns. The US Aggregate Bond index gained just 1% last year, equal to investment grade corporate, mortgage-backed, and national muni bonds. High yield bonds carried the year with a gain of 8%, followed by the international aggregate index, up 5%.
Where We Are
Source: Factset
June finished at fresh all-time high. The S&P 500 reached a new high of 6204 on June 30, up 6% YTD in total return. The index is up 28% from the intraday low on April 7. The Nasdaq 100 has rebounded 37% from the same day's intraday low, and is also at an all-time high. Stocks reached extremely oversold levels during the final week of March and the first week of April, but have risen for 7 of the past 12 weeks.
The US Aggregate Bond index is up 4% YTD (60/40 is up 5.2%). The 10-year T-Note yield is at 4.2%.
Q1 Results. With 100% of S&P 500 constituents reporting, 63% exceeded revenue estimates, with 5.0% y/y growth vs. the 5.1% forecast at the beginning of Q1. 78% of companies have beaten EPS estimates, with average growth of 13.0% vs. the 11.2% expected.
S&P 500 earnings expectations. For 2024, actual EPS was $240/share, up 12% vs. 2023. The 2025 estimate is $263 (+9%), even with last month. The 2026 estimate is $299 vs. $298 (+14%), with 2027 at $336 vs. $337 (+12%). Each of the annual consensus estimates are within 1% of where they were 60 days ago.
P/E ratios for those estimates are 23x, 21x, and 18x. The P/E-to-Growth (PEG) ratios are 2.3, 1.6 and 1.4. The average EPS growth rate over the past 25 years is 11%; the average P/E and PEG ratios are 21x and 1.9. The consensus price target for the SPX is 6688 vs. 6544 a month ago and 6543 sixty days ago, for an implied total return of +8% from its current level. If achieved during this calendar year, the implied total return for the S&P 500 index in 2025 would be +14%.
Where We’re Headed
Corporate fundamentals continue to grind higher, despite policy uncertainty. Quarterly earnings results were better than expected in the last two periods, during the height of the political season, and during the height of tariff policy volatility. Annual earnings growth for the S&P 500 index is now expected at 9% in 2025, down from a 12% growth rate anticipated at the beginning of the year. And as much as the decline in the growth rate can be reasonably attributed to trade, tariff and inflation policies, a higher estimate in January vs. July is a regular occurrence among analysts – positivity tends to be high after Christmas and New Year’s Eve, if for no other reason that is seems like a fresh start. In any case, the projected, consensus earnings growth rate decline from 12% to 9% in 2025 has been added to 2026, which was 11% at the start of the year but now stands at 14%. The consensus 2027 EPS estimate has also risen from 12% to 13%. The macro environment supporting this growth is based largely on the continued strength of the US labor market, inflation which keeps trending lower toward the Fed’s 2% target, and a resolution of outstanding tariff agreements which are being tied off month by month.
What hasn’t been noticed in all this is the positive potential effect on corporate cash flow. Lower and stable tariff policy, combined with lower inflation, less wage pressure, and lower interest rates (lower cost of capital) means relief to profit margins. In terms of the S&P 500 constituents, the estimated pretax profit margin is expected to rise 300 basis points between 2024-2027, or from 17% to 20%. At the same time, net debt to cash flow (EBITDA) is expected to drop from 1.3x to 0.8x. The result of these changes on free cash flow estimates (in broad terms, operating cash flow minus working capital changes and capital expenditures) is significant: following just a 5% increase this year (only six months to go), consensus estimates project a 22% increase in FCF in 2026, followed by another 18% in 2027.
And speaking of uncertainty… On the next page is a chart of the Dow since 1945. Accompanying that price chart is a list of major negative events, though not exhaustive. In addition to the reminder that markets reflect corporate profits over time and tend to “climb the wall of worry”, a careful read will reveal that in just the past 25 years, about 60% of those contained negative news related to wars and terrorist attacks – somewhere in the world. Most of us wouldn’t remember all of them off the top of our heads, or believe they were less frequent.
One of the takeaways is that markets are forward looking and don’t remember the past the same way we do. Technical indicators like support and resistance are part of that behavioral memory, but constant fear and anxiety are not. Those are current manifestations of the uncertainty of future events. But when has the future ever been certain? Whether with weather or wealth, time and chance happens to all. And worrying wears against wisdom, making things worse.
In other words, try to take the data at face value, and let tomorrow worry about itself. When times are great and everything seems to be looking up, don’t get caught up in the euphoria. Conversely, when times are tough and the sky seems to be falling, don’t get caught up in the despair. Reversion to the mean is a good rule of thumb.
Soure: Factset
