2024 has been one of the best years for the stock market. The S&P 500 has gained a remarkable 27% year-to-date, led by tech giants like Nvidia and Apple. The Dow Jones is also up 17%, and market optimism continues to grow. After President-elect Donald Trump’s victory, the markets surged even further, gaining an impressive 5-6% in just a week. However, with these rapid gains, we may be heading into unsustainable territory.
Investors are banking on Trump’s proposed economic policies, including “Drill Baby Drill,” corporate tax cuts, promoting cryptocurrency, and imposing heavy tariffs on imports. These policies have sparked enthusiasm in the market, which is now pricing in expectations of immediate high returns.
Trump’s Policies and Their Impact
Drill Baby Drill:
Historically, Republicans have supported increased oil drilling, and this is likely to continue under Trump’s presidency. However, it won’t be as intense as during his first term. Major companies are now committed to sustainability goals, with carbon neutrality targets by 2030. While “Drill Baby Drill” may provide a short-term boost for oil companies and temporarily lower fuel prices, it will only delay the adoption of electric vehicles (EVs) by a few years. The trend toward EVs is still growing, and that momentum is unlikely to stop.
Corporate Tax Cuts:
The 2017 corporate tax cuts, which reduced the rate from 35% to 21%, significantly boosted corporate profits, dividends, and stock buybacks. These cuts benefited shareholders, but the long-term benefits for the broader economy have been less clear. Much of the savings went toward stock buybacks rather than capital investment or job creation. The cuts also added about $1.5 trillion to the national debt, raising concerns about sustainability and economic stability. While they provided immediate gains for corporations, questions about long-term debt and income distribution remain. Trump now wants to reduce the rate even further from 21% to 15% for companies that manufacture in the country.
Tariffs on Imports:
Increasing tariffs on imports can lead to higher costs for businesses and consumers. Companies reliant on imported materials face increased production costs, which often results in higher prices for consumers or reduced profit margins. These tariffs make it harder for businesses to compete and reduce consumer purchasing power, slowing economic growth. Retaliatory tariffs from trade partners can further escalate into trade wars, harming international trade and job growth. While tariffs aim to protect domestic industries, they can ultimately hinder economic growth and stability.
S&P 500 and Market Valuation
The price-to-earnings (P/E) ratio is a useful metric for determining whether the stock market is overvalued or undervalued. The modern-era average P/E ratio for the S&P 500 is 20.4, but the current P/E ratio is 30.5, which is 49.5% higher than the average. This suggests that the market may be overvalued, putting pressure on companies to meet high expectations. If earnings do not consistently grow, a correction is likely.
Historical P/E Ratios and Corrections
Historically, the average P/E ratio for the S&P 500 has been around 20.4. In times of optimism, it can rise above 25, but during corrections, it often falls to around 15. The current P/E ratio of 30.5 is well above the historical average, indicating potential overvaluation and the risk of a market correction.
Earnings Growth and Economic Conditions
Assuming a typical earnings growth rate of 10% annually, we can consider two possible scenarios for the future value of the S&P 500:
Scenario 1: Heavy Correction (P/E = 22)
If the P/E ratio falls to 22, with a 10% growth rate, the projected value of the S&P 500 would be approximately $472.89—a 20.66% decrease from today’s value of $596.
Scenario 2: Moderate Correction (P/E = 25)
If the P/E ratio drops to 25, with a 10% growth rate, the projected value would be approximately $537.38—a 9.84% decrease from today’s value of $596.
Considerations for the Forecast
The S&P 500’s future value will depend on macroeconomic factors like interest rates, inflation, geopolitical risks, and investor sentiment. If the P/E ratio sharply corrects to the historical mean or lower, we could see a steeper decline, particularly if earnings growth falls short or economic conditions worsen. On the other hand, if investor confidence remains high and there are expectations of technological advancements or stimulus measures, the market could sustain a higher P/E ratio.
Possible Outcomes
Best Case:
Stock values remain steady in 2025, and tech stocks deliver strong returns, finally justifying their high valuations, which seems less likely.
Or, future returns may be modest at around 4-5% annually, instead of the historical 8-10%.
Worst Case:
The Federal Reserve’s work over the past few years is undone, leading to inflation and a return to high interest rates, which could negatively impact the economy for years.
Most Likely:
The market undergoes a correction in 2025, with a dip of 10-20% across the board.
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