At the end of 2023, the S&P 500 index was trading at 19.8 times forecast 2024 earnings, having risen 24% in the year. The MegaCap Eight, according to Ed Yardeni of Yardeni Research, was trading at 28 times 2024 earnings and the rest of the market at 17.3.
Although the consensus expectation of a recession in 2023 had been proved wrong, some economists were still predicting one in 2024. Worries about inflation were common and the advice of most pundits was to switch from the “overvalued” US market into the rest of the world, on a forward multiple of 13.
How wrong that would have been. American equities rose 24.4% in 2024 to trade on a prospective multiple of 20.7 times 2025 operating earnings, compared with a return of 5% for the rest of the world in US dollars. While 4.5% of the rise in the US was attributable to a further market rerating, nearly 20% was due to earnings growth.
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With the rest of the world trading on 13.2 times forward earnings at the end of the year, earnings growth was 8.8%. With gains of between 14% (Microsoft) and 182% (Nvidia), the MegaCap Eight again outperformed the S&P 500.
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The sceptics spent much of 2024 trying to work out why they had been wrong about the US economy, inflation and the stock market. In a report entitled The Relentless March of American Exceptionalism, Louis Gave of Gavekal noted that “US growth stocks have outperformed global value stocks in 16 of the past 18 years. To say that this is an impressive performance would be a massive understatement”.
He added that “the US, with 4% of the world’s population, roughly a quarter of global GDP and a third of global profits, now accounts for more than two-thirds of the MSCI World index’s capitalisation”.
He explained this with the familiar litany: a much cheaper cost of energy than any other developed economy; the world’s biggest domestic consumer market; and the US dollar’s position as the world’s trading and reserve currency.
Curiously, he failed to mention America’s extraordinary record of innovation, as illustrated by the phenomenal rise of the MegaCap Eight and many others, and the reacceleration of productivity growth in the last 15 years, in sharp contrast to the UK and much of Europe.
What could go right for the US economy?
Like other sceptics, he went on to identify what could go wrong, from sanctions backfiring to the displacement of the dollar and the shale revolution fizzling out. A more interesting question is to ask what could go right, justifying continued US outperformance.
Perhaps the answer lies in the “3-3-3” strategy of Scott Bessent, incoming president Donald Trump’s proposed treasury secretary: 3% budget deficits, 3% real GDP growth, and three million barrels of oil equivalent per day. Many commentators believe this to be impossible, particularly in the context of the current budget deficit of 6% of GDP and Trump’s intention to cut taxes. But what if it isn’t?
Growth of 3%, assisted by higher energy output and a deficit of 3% would stabilise the US’s debt to GDP ratio, potentially allowing bond yields to fall. Deregulation and tax cuts should stimulate growth, more than counterbalancing the consequences of sharply reduced government spending. Sustained or higher productivity growth would be positive for corporate earnings and lower bond yields would justify high valuations.
Yardeni, whose optimism about the market was vindicated in both 2023 and 2024, remains optimistic, with an S&P 500 target of 7,000 by the end of 2025, a 19% gain. He calls this “the Roaring 2020s scenario” and expects it to continue into 2026. The 3.3% market setback of recent weeks could extend to 10% in the short term, but that would be a buying opportunity.
He expects corporate revenues to grow 5%, profit margins to widen and “earnings per share to increase from roughly $240 to $285”, with $320 in prospect for 2026 and 360 for 2027. Hence the S&P 500 forecast of 7,000 by the end of 2025, 22 times 2026 earnings. This forecast is based on annual productivity growth climbing to 3%-3.5%, strong household and corporate spending, “sticky” inflation and a pause in interest-rate cuts. Productivity growth keeps unit labour costs low.
So when do other markets start to perform like the US? When they pursue a comparable economic strategy: energy self-sufficiency (or better), lower taxes, deregulation, far lower public spending and budget deficits in line with economic growth.
At present, Britain and much of Europe are going in precisely the opposite direction, but that will change as the success of these policies in the US, Argentina and southern Europe becomes apparent.
In the meantime, pessimism about growth in the UK and northern Europe leaves little room for negative surprises and though government finances are severely stretched, the corporate sector is in good shape and consumers have delevered to such an extent that it is doubtful whether lower interest rates would actually help economic growth.
Very little debt is at floating rates of interest, but many deposits are. Inflation paranoia is everywhere but slow or negative monetary growth, thanks to the collapse of credit growth by the banking sector after the 2008 financial crisis, means that fears are overdone. Non-US markets may continue to lag the US in 2025, but the overall pessimism looks exaggerated.
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