Where We Are Now
You can count on two things every December: holiday celebrations and the slew of Wall Street forecasts for the coming year. We don’t find much value in estimates of what precise level the S&P 500 will land 365 days from now. But we do think it’s a worthy exercise to think about the potential opportunities and risks that lie ahead. Of course, this first requires an accurate assessment of where we are now.
As of this writing, the S&P 500 has enjoyed a total return of 29% year-to-date. Stocks have benefited from continued economic growth, helped by resilient consumer spending and progress in bringing down inflation. In addition, large tech stocks have gained from big investments in artificial intelligence. We’ll take it. But these outsized gains have left a U.S. stock market that we consider expensive: On a price-to-earnings (P/E) ratio based on next year’s earnings estimates, the S&P now trades at a more expensive level than it has 95% of the time during the last 30 years.
International stocks have participated in the rally, but to a lesser extent: They have gained about 9% total year-to-date. The growth of major global economies has been less robust than America’s, and a stronger U.S. dollar has been a headwind for international investments. Because of more modest gains for international stocks, their valuations remain more reasonable than U.S. stocks’, though: Their current P/Es are generally in line with their long-term averages.
U.S. stocks should always trade at a premium (i.e., higher P/E ratio) than international stocks, for good reasons. They will always make up the lion’s share of the equities in client portfolios. However, when you overlay how expensive U.S. stocks are now with the reasonableness of international valuations, that premium is now at an extreme (see the exhibit).
Exhibit: Valuations of International Stocks Relative to U.S. Stocks
Source: FactSet, MSCI, Standard & Poor’s, J.P. Morgan Asset Management, Clayton Wealth Partners. Data are as of December 13, 2024.
Valuations are a condition, not a catalyst. In fact, there is no correlation between stock valuations and their near-term returns. (In the short run, expensive stocks can get more expensive, and cheap stocks can get even cheaper.) U.S. stocks have been relatively expensive for a while, yet we have held a greater percentage of them in client portfolios than our long-term target allocations. That has worked well. But at some point, we will look to take the relative weightings back to long-term targets and perhaps even temporarily allocate more to international stocks if we see the opportunity.
Bullish
- The Fed has made good progress in reducing inflation since 2022.
- The Fed is now in an easing cycle and looks to cut rates aggressively.
- Consumer spending seems to be supported by a healthy, yet cooling labor market, along with household investment income and wealth.
- The most attractive yields for fixed income and cash in years.
- Consumer and corporate balance sheets generally remain healthy.
Bearish
- Slowing global economic growth.
- Banks are tightening lending standards for consumers.
- Housing affordability remains at a decades-low.
- Leading indicators of unemployment are generally trending down
- Delinquency rates on consumer loans are rising
- Russia-Ukraine war, Middle East conflict, and other geopolitical concerns.
- China is experiencing a growth recession, with deflation fears growing.
- Federal debt and deficits have ballooned.