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
The US Aggregate Bond index is up 6.8% YTD (60/40 is up 13.2%). The 10-year T-Note yield is at 4.09%.
Q3 Results. With 63% of S&P 500 constituents reporting, 80% beat revenue estimates, with 9% y/y growth vs. the 5% forecast at the beginning of Q3. 83% of companies have beaten EPS estimates, with average growth of 11% vs. the 7% expected.
S&P 500 earnings expectations. For 2024, actual EPS was $240/share, up 12% vs. 2023. The 2025 estimate is $267 (+12%), flat vs. a month ago. The 2026 estimate is $304, up $2 over the last month (+14%), with 2027 at $346 (up $4) vs. $341 (+14%). Each annual estimate is higher than it was six and twelve months ago.
P/E ratios for those estimates are 26x, 23x, and 20x. The P/E-to-Growth (PEG) ratios are 2.2, 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 7741 vs. 7376 a month ago and 7244 sixty days ago, for an implied total return of +13% from its current level. If achieved during this calendar year, the implied total return for the S&P 500 index in 2025 would be +30%.
Where we're headed
Don’t Fight the Fed...again? At present risk assets have cause to cheer. Cuts to Fed funds are presumably about 2/3rds done since August of last year, when Fed Funds were at 5.25-5.50%. We’ve now seen five rate cuts, the latest last month, and are currently at 3.75-4.00%. Based on current consensus (Factset), expectations are that Fed Funds will cut another 25bp in December, and 50bp in 2026. At that point Fed Funds would stand at 3.00-3.25%, and be just above expected Core inflation by 2026 year end (3.0%).
As we wrote last month, there has not been a time over the past twenty years during which equities didn’t rally during rate cuts, even when within 2% of record highs. The average gain during those periods was 14%, based on data compiled by the Carson Group. As such, and given the overall economic and earnings environment, it is quite possible that the track record continues, and the S&P 500 does indeed reach its current consensus target level of 7740, which is an implied gain of 14%.
Hopefully Goldilocks won’t die in the process. In order for the Fed to continue its dovish ways, the labor market and broader inflation measures must stay weak “enough”. If employment, wage inflation, and overall price inflation retreat again to a sub-3% level, the Fed can justify more cuts, especially given that the past 30-year average of CPI inflation is 2.9%. Though this level is above the FOMC’s “target” of 2%, the Committee has room to cut if inflation does indeed return to a 2.5% range by 2026-2027, as is currently estimated. What you see below helps the Fed in this regard, as it reflects low, monthly job gains over the four months.
The tricky part is what is shown in the first chart above. It reflects consensus around the level of Fed Funds. Although consensus still calls for 3.25% by 2026, the probability of the FOMC staying at 3.75-4.00% at the December meeting has risen since last week from about 10% to 40%. Job growth aside, earnings estimates are still rising, against better-than-expected results and outlooks. So for the time being, prices are being driven by strong index fundamentals - while we all keep a weather eye on the Fed, and its pursuit of perfect porridge.
Sources: Morningstar, Factset. Performance data represents past performance and is no guarantee of future results. This material has been compiled from sources deemed reliable; it is not guaranteed as to its accuracy and does not purport to be complete. All information contained herein is subject to change without notice. The information is not intended to be used as the basis of investment decisions. The information contained in this material is provided for general informational purposes only and is not intended as investment advice.".