Led by technology megacaps for a second consecutive year, the stock market enjoyed solid returns in 2024, with the Dow Jones Industrial Average, S&P 500 and NASDAQ Composite rising 12.88%, 23.31% and 28.64% respectively.   Indeed, the Magnificent 7 (Apple, NVIDIA, Microsoft, Alphabet, Amazon, Meta and Tesla) accounted for a lopsided 53.5% of the S&P 500’s 2024 advance.  With a combined market capitalization of approximately $16.4 trillion, the Mag 7 now accounts for almost one-third of the market cap of the entire S&P 500 ($51.6T).  Apple, the largest of the Mag 7, seems destined to surpass $4T for the first time, a seemingly unthinkable market cap only a few years ago and a size x would make it only 13% less valuable than the entire S&P Mid Cap 400 and S&P Small Cap 600 combined ($4.6T).

Technology’s strong relative performance is directly correlated to remarkable earnings growth. According to FactSet, earnings for the Mag 7 grew 33% on average in 2024, compared with 4% for the other 493 constituents of the S&P 500.  While the rate of earnings growth for the Mag 7 is expected to remain strong, it is slowing on an absolute basis and expected to slow relative to the rest of the market as we work our way through 2025.  For context, Mag 7 earnings grew by 24% in the fourth quarter of 2024 (compared to 33% for the full year) and are expected to slow further to 18% by the fourth quarter of 2025.  At the same time, earnings for the “other 493” are expected to grow by 14% in the fourth quarter of 2025 compared to 4% in the fourth quarter of 2024.  As earnings growth for the broader market begins to catch up to technology’s darlings, we expect at least some rotation away from the Mag 7. 

While the disparity in earnings growth between the Mag 7 and the “other 493” has been notable, so too is the widening disparity in valuation.  The Mag 7 now collectively trades at 32x forward 2025 earnings, compared to 23x forward 2025 earnings for the S&P 500 and 18x forward 2025 earnings for the “other 493.”  This valuation for the S&P 500’s castaways appears even more reasonable considering the accelerated growth in earnings forecasted for the collective group.  It is very rare for such concentrated market leadership to continue for extended periods, and we expect reversion to the mean to permeate the market landscape in the coming years. 

We also foresee heightened volatility ahead with increasing odds for a meaningful pullback in the coming months.  While the consensus calls for deregulation and lower taxes to usher in accelerated GDP under the new Trump administration, we also believe that uncertain tariff and immigration initiatives, and the subsequent impact on inflation, have the propensity for negative surprises. 

Moreover, the market has become increasingly concerned that the Fed is once again more worried about rising inflation than maximum employment.  After cutting the Fed Funds rate in December by another 25 basis points to a range between 4.25% to 4.5%, the Fed telegraphed only two more quarter-point cuts in 2025, half the number of cuts expected by the Fed only three months ago.  The yield on the benchmark 10-year Treasury bond subsequently catapulted from mid September’s 3.6% to just under 4.6%, an incredible 25% jump in yield in less than four months. While core PCE recently rose below forecast by a scant 0.1%, this Fed-favored measure of inflation remains at 2.8% on an annual basis and stubbornly above the Fed’s 2% target.  The Fed intends to be vigilant in fighting inflation and will require additional evidence that disinflationary trends are intact before cutting rates much further.  While higher for longer interest rates may weigh on companies with challenged balance sheets, we would expect higher rates to be accompanied by a stronger economy and rising earnings which should benefit the overall stock market.

The secular trend of deglobalization and concurrent reshoring of manufacturing capacity in the United States will only accelerate under the new Trump administration.  At the same time, economies throughout the rest of the world, especially Germany, France, Brazil, China and Japan, are all either on the brink of recession or mired in economic stagnation.  Lower growth and lower interest rates throughout the global economy should make dollar-denominated assets more attractive and help keep a lid on interest rates.  Especially relative to the rest of the world, the supertanker U.S. economy is in great shape and our markets vastly more attractive for investors.  With consumer spending accounting for 70% of U.S. GDP and U.S. exports accounting for only 11%, the United States is well prepared for the emerging era of isolationism. 

Recent research from Goldman Sachs cautions investors to expect annualized returns of 3% or 1% after inflation for the next ten years, citing steep valuations and extreme concentration in technology as primary culprits for this anticipated period of meager returns.  On the other end of the spectrum, Economist Ed Yardeni is calling for big productivity gains driven by AI to lead a “Roaring 20s” renaissance where the S&P 500 hits 10,000 by the end of the decade.  We suspect that market returns will fall somewhere between these two extremes.  Even the more bearish Goldman research suggests an equally weighted allocation strategy as antidote for investors to beat the expected doldrums. 

While we again would not be surprised by a pullback in the coming months, we do expect the S&P 500 to reach at least 6,500 in the year ahead.  With consensus estimates at $280 for 2025 S&P 500 earnings, reaching that level implies no change to the overall market multiple.  That said, we expect eventual rotation to the “other 493” to lead a period of sustainable reversion to the mean that may be hidden below the surface by the dominant weight of the Mag 7.  Because the Mag 7 looms so large, even massive moves by the S&P 500’s smaller constituents will not move the needle for the overall market.  Conversely, should any of the megacap leaders disappoint or stumble, such surprises would have a disproportionate effect on the market indices. We expect an equally weighted strategy focused on quality and dividend growth to continue to serve our clients well, especially on a risk-adjusted basis.                

Vantage Wealth

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