According to
Yardeni, (figure 7) analysts think the S&P500 will earn 243.31 in 2024 (up 10% from 221.36 in 2023). In 2025, earnings are expected to be 273.73, 12.5% higher than in 2024.
Margins, meanwhile, have been growing since 2023 and may approach 14% in 2025.
Operating earnings are expected to grow 14% (
Yardeni, figure 10).
It would be erroneous to say stocks will simply rise with earnings, margins, or operating earnings, because two other big factors are involved: leverage and valuation. S&P500 companies on average ended 2024 with a
debt/equity ratio of about 0.95, and a P/E ratio of 30.5.
Leverage increases the effect of rising earnings and rising margins on the value of equity, such that equity values can rise faster than earnings. This is how the S&P500 typically grows faster than its earnings. Valuation, on the other hand, has some very long-term mean reversion characteristics. Those mean-reverting pressures probably strengthen as we approach extreme levels, like a PE ratio of 30.5. So 2025 will be a tug of war between these fundamental forces, with growth*leverage pushing stocks up and valuation pushing down.
The chart says PE ratios above 30 have only been sustained for a few months at a time, historically. The PE sneaked above 30 for a few months in 1998-1999, again for almost a year in 2001-2002 during a recession, for almost a year in 2008-2009 (though this one was due to ttm earnings falling faster than stocks), and then for a few months between mid-2020 to early 2021 (due to earnings growth falling).
The relevant example would seem to be the late 1990s because that was a period of fast growth, no recession, and high valuations, among other similarities. All other examples of the S&P500 having a PE>30 occurred around recessions, when the trailing twelve months of earnings fell faster than the stock price. Investors price stocks based on the expectation of a return to growth in the future rather than the past, so they buy even when earnings are falling.
The 1998-1999 episode was resolved by
high earnings growth, supporting a boom in prices of almost 30% in '98. Could the same occur in 2025, or did it already in 2024? If stock prices stayed the same, and earnings rose 14%, then the S&P500 would have a PE of 26.7 this time next year.
I think it could occur, and I think valuations are supported mostly by hope of fast earnings growth. That hope could be / will eventually be pierced if unemployment rises, or inflation rises.
I'm staying hedged to capture most of the upside and avoid most of the downside.