
In our last commentary, we talked about how we believe that after two strong years in the financial market, that 2025 will be tougher, but still positive. The risks we see for this year in the market are due to elevated equity valuations, unsustainable government budget deficits, and well-known geopolitical risks. In this commentary, we will attempt to put more details on the range of outcomes we see, as well as why we believe a market sell-off will find institutional investor support.
When looking at the range of market outcomes for 2025, Wall Street takes the earnings estimates of all of the publicly traded companies and then applies a multiple on those earnings to come up with a price target for the year. In this tradition, for the S&P 500 (the largest 500 companies in America) Wall Street earnings estimates as of December 11, 2024, are currently at $268 per share (with a range of $248 to $285), and the forecast for 2026 is currently $300 per share (with a range of $275 to $320) according to Bloomberg News. Next, if you divide the S&P 500 earnings average ($268) number by the current price of the S&P 500 ($5,881 as of 12/31/24) you get a price/earnings ratio of 24.20. If the analyst earnings estimates are correct, which they seldom are, (they usually start the year a little high), and if the market continues to trade at 24.20 times earnings, then we can expect the S&P 500 to end at a price level of $6,485 (268 x 24.56) by the end of 2025, which would be a gain 10.2% for 2025. The other data piece to look at is how the current valuation levels as measured by price/earnings compare to historical numbers. Unfortunately, this is where we see some weakness for this year. Historically, the S&P 500 has traded at closer to 20 times current earnings, which is much lower than the then-current level of 24. If the market were to revert closer to the historical average of 20 times earnings, and the earnings per share on the S&P 500 grow to $268 a share by the end of calendar year 2025, then the price estimates of the end of calendar year 2025 drop to $5,360, which would be a decline of -8.8% from the current level of $5,881.

So, this gives us a price range on the S&P 500 and expected volatility of between $5,360 on the low side (which would be a -8.8% loss) and $6,485 or a positive return of +10.2% for calendar year 2025 on the upside.
When we look at the conglomeration of Wall Street Analyst estimates to get an idea of professional opinions, Seeking Alpha’s Wall Street Breakfast Sentiment Survey for 2025 shows the average price target of the S&P 500 for next year is 6,241, marking an upside of 5.6% from the current level of 5,881. These estimates reveal that we will be looking to buy into weakness and be more conservative in the meantime to start the year 2025. Of course, as earnings adjustments come in throughout the year these numbers will be adjusted as well.
One of the adjustments to earnings that we are already seeing is that the U.S. dollar is getting stronger when compared to other currencies. Since the election, the U.S. dollar is up 5% compared to developed nation trading partners, and the U.S. dollar is now the highest it has been since the 1985 currency intervention reached at the Plaza Accords. The Plaza Accords were a market intervention to bring the value of the dollar down to help reduce the size of the American trade deficits. The dollar has been moving higher versus other currencies because traders are betting that President Trump’s pro-growth economic policies and his tariff policies will also create unwanted inflation. This unwanted inflation will then cause the Federal Reserve Bank to raise interest rates to fight inflation.
The strong dollar could also hurt the stock market because the average company in the S&P 500 earns half of its income overseas, so if the dollar goes up another 5%, then those earnings estimates we just mentioned will be reduced by the currency adjustments when translated back into dollars, because the foreign currencies now buy less U.S. dollars. In this case, that would mean the earnings estimates on the overall market are already 2.5% too high, and that the stock market projections will be lower than expected due to lower earnings caused by a high dollar versus other currencies.

Another headwind for corporate earnings is that the economy is demonstrating more bifurcation of spending between the well-off and the struggling. Consumer spending, excluding car sales, rose 3.8% from Nov. 1 to Dec. 24 compared with a year ago according to MasterCard SpendingPulse. This is a solid number, but it is being driven by wealthier consumers. The wealthier households have benefited from the stock market and housing gains. Lower-income consumers, by contrast, who do not own a home or have stocks, have been disproportionately squeezed by higher-priced rent, groceries and other necessities, leaving them less likely to spend on discretionary items, like electronics, entertainment, and restaurant meals. The financial strain on lower-income Americans is reflected in credit card debt. Credit card lenders wrote off a staggering $46 billion in seriously delinquent loan balances during the first nine months of 2024. This figure, representing a 50% increase from the same period in 2023, is the highest in 14 years, according to data from BankRegData.
The “Wealth Effect” created by rising stock prices and homes has been quantified by Ned Davis Research. According to Ned Davis Research, since 1960, changes in household net worth explain 36% of the year-over-year change in consumption with a one-quarter lead. Moreover, for every 1% increase in household net worth, they see a 0.4% year-over-year rise in consumption one quarter later. Net worth is taking on an increasingly larger role in the economy. Household net worth hit $169 trillion in Q3 compared with nearly $30 trillion Gross Domestic Product (GDP) for the economy, or 575% of GDP. (Ned Davis Research) That’s about 75% more than it was a generation ago. This matters because the top 60% of consumers (where the wealth is) account for nearly 80% of consumption. The bottom 40% account for just over 20% of the spending. Putting aside whether this is equitable or fair, asset owners are doing well financially and supporting the economy, while those in debt with little to no net worth are not. What is concerning is that if the stock market does not continue to rise, this wealth affect could reverse while the bottom half of the country is already struggling. Another major headwind facing the economy and corporate earnings is that the nation’s balance sheet has deteriorated substantially over the last decade. More to the point, the federal budget deficit was 6.2% of GDP (Gross Domestic Product) in FY (Fiscal Year) 2023 and 6.4% in FY 2024, which ended on September 30. To put these in historical perspective, during the 1980s, President Reagan was criticized for running overly large budget deficits. And yet the largest deficit ever run under Reagan was 5.9% of GDP in FY 1983. But Reagan had two acceptable excuses for that deficit. First, he was fully funding the Pentagon at the height of the Cold War. Second, and more importantly, the unemployment rate that year was 10%, meaning spending on unemployment and welfare was elevated. There are no similar excuses for the past decade. Indeed, in the past two fiscal years, the unemployment rate averaged less than 4% and we aren’t at war (First Trust Data). The big question for the next few years is how quickly the federal government can wean itself from an addiction to big budget deficits and whether it can successfully implement pro-growth policies at the same time to offset this loss of spending in the economy. If government spending really is cut, and the government becomes a smaller burden on the private sector, that will boost growth – in the long-run. But if there are less dollars sloshing around in the economy, that will hurt short term growth in the short term.

While we do see risk for this year in the market due to valuations, government budget deficits, and well-known geopolitical risk, we do not see a market crash, but rather a market correction. There are several reasons why we believe the market will find support in a sell-off. One of the primary reasons we see that there will be support in the market if prices drop is because of the record amount of money in money market funds which we talked about in our last commentary. In that commentary, we pointed out that six trillion dollars is in money market funds, and as interest rates reset to lower rates, that money will move over to dividend-paying stocks. In addition, there is another $300 billion in North American private-equity funds and another $200 billion in global private-equity funds that have raised money from investors but have not yet invested this money into companies. This money needs to be invested for private equity firms to collect fees, and these companies are looking to buy into a market sell-off which will cushion selling pressure.
Another reason for optimism in case the market does sell off is that American productivity has now shown 5 straight quarters of 2% or more productivity growth in the USA. This trend looks like it will continue and even increase as a wave of artificial intelligence and robotics looks to allow fewer workers to accomplish more with less. In the long term, the growth of the economy is population growth multiplied by productivity growth, so if these trends continue, long-term growth rates could be revised higher. In conclusion, the last two years have seen strong stock market gains, but we are now seeing issues that concern us. Equity valuations have risen, geo-political risks are high, and the U.S. government’s ability to come to the rescue in a future crisis has been diminished due to the nations’ growing debt load. However, we think the large amount of cash on the sidelines in money market accounts will help cushion any market sell-off. As a result, we continue to favor large capitalization, brand name equities who are providing goods and services that consumers and businesses need on a daily basis and who are returning cash back to investors as the best risk-adjusted returns.
Thank you for your continued support.
Sincerely,

Bonus 401k Catch Contribution Reminder: The Secure 2.0 Act is raising the catch-up contribution limit for workers. Beginning this year, participants in 401K or other employer-provided qualified retirement plans who are age 60, 61, 62, or 63 by December 31st, 2025 can take advantage of the Super Catch-Up Contribution, which is $11,250 instead of $7,500. Please remember to take advantage of this tax deduction.
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