2024 S&P 500 Forecast: A Bull Market On Borrowed Time (NYSEARCA:SPY) (2024)

I feel like an oversexed guy on a desert island. I can't find anything to buy."

-Warren Buffett, 1973.

The S&P 500's (NYSEARCA:SPY) run for the year has continued with stocks up nearly 20% for 2023, despite earnings being flat for the year and leading economic indicators continuing to worsen. The action has been driven almost entirely by the "magnificent seven" mega-cap tech stocks – now up over 100% for the year on average, with the equal-weighted S&P 500 index (RSP) actually underperforming cash as of my writing this. The playful irony here– The Magnificent Seven is an old Western movie and four out of the seven are killed by the end of the film. With nosebleed P/E multiples and hockey-stick growth projections, whoever anointed the mega caps with this name likely had a sense of humor, and/or lived through previous bubbles such as 1980s Japan, 1990s dot-com, and the 2000s housing market. Many investors are saying this time is different, but that's what they say every bull market.

Valuations are high, and 2024 earnings estimates are implausible when you consider the macro context. It's normal for stocks to go up over time, but for price rises to be sustainable, stock prices should rise at roughly the same pace as the earnings of their underlying businesses. However, prices have risen much faster than underlying earnings, putting a big question mark on the sustainability of the current bull market.

In contrast to the ZIRP era, investors now have ready alternatives to the S&P 500 (SP500) that carry much less risk. Interest rates are key competition for stocks, and stocks are not realistically priced to offer much return in excess of what you can earn in safer investments. While some individual situations exist abroad and in individual names at home, the overvaluation of large-cap US stocks is severe. Buffett's desert island quote is tongue-in-cheek, but the move here seems to be to play things safe and let the market bring opportunities to you at a later date. For what it's worth, stocks crashed 50% shortly after in 1974, leading Buffett to quip that he felt like an oversexed man in a harem. The success of Berkshire's picks during the resulting bear market fire sale made history.

• Cash (VMFXX) is paying roughly 5.5% with no risk to principal.
• Bonds (VBLTX) are paying about 5% with the potential for moderate amounts of capital gains over time. High earners may consider municipal bonds instead (VWALX).
• Niche investments like bank preferred stocks are offering 6-7% yields if you're comfortable with making investments that are somewhat illiquid.

Finally, 2024 is an election year in the United States. No forecast of the stock market and economy would be complete without considering the election and what some of the consequences might be for the economy and stock market. Politics don't always affect stocks as much as partisans want you to think, but current government spending is uniquely unsustainable, making the election a bit of a minefield for investors.

S&P 500 2024 Earnings Outlook

Analysts currently expect $245 in earnings for the S&P 500 for 2024, up from $209 in 2021, $218 in 2022, and roughly $220 in 2023. The S&P 500 is trading around 4550, which is a bit shy of 21x current-year earnings and 18.5x 2024 estimates. The trouble here is manifold.

• 21x earnings is a very high number in general for stocks. This is higher than roughly 95% of history, and these high valuations imply low returns going forward for investors. The long-term average P/E ratio is around 16x for large-cap stocks– that would imply a fair value of 3520 on the S&P 500 even if earnings hold up. Since it's an average, half the time PE ratios have been lower than this, flagging a large potential downside at some point for stocks. You're supposed to get long-term compensation above the rate of cash for the volatility and risk of buying stocks, but you're not getting much of that now due to how high prices are.
• Earnings themselves are inflated due to government stimulus and consumer savings rates being near record lows in the US. Households are worse off in inflation-adjusted terms than they were in 2019, but they're spending more. The difference is reflected in lower savings rates and putting more on credit. This isn't sustainable.
• Earnings estimates are generally too high for future years, and analysts almost always revise them down as the year goes on. There's actually a lot of evidence that earnings growth in the US has been driven by interest rate decreases and tax cuts, while the underlying corporations are quite bloated and inefficient. If the junior high school drama at Open AI over the past month is any indication, new technology probably isn't going to radically change this.

For some of the most informative papers you'll ever read, check out economist Michael Smolyansky's research at the Fed– he proves that the high returns of stocks in the last 15 years were due to cutting the corporate tax rate in the US from 35% to 21% and a dramatic drop in interest expense for companies. Not only are these drivers not sustainable at their current pace, but they're likely to reverse, completely blindsiding investors expecting high returns. You can check out a well-prepared summary here or dive deep into the mathematical proof here. I always thought this was an interesting graph from his research– it shows that stock prices rose faster than net income (speculation), which in turn rose faster than pre-tax income (deficit-financed tax cuts), which in turn rose faster than EBIT (artificially lower interest rates). About 40% of the overall return in the stock market since 2004 is nothing but air.

I have another approach to ballparking corporate profits, which is simply taking pre-pandemic earnings and adjusting for the size of the money supply and economy now. The S&P 500 earned $163 in 2019, while nominal GDP is up about 26% since then. We'll tack on another 6% to account for Q4 next year's growth (1.26*1.06), and we get a nominal GDP that's about 1.335x what it was in 2019. That gets us an earnings estimate of $217 for 2024, about what we earned this year. $217 is about 10% below the current analyst estimate for 2024, and it would be a huge slap in the face to bullish analysts and speculators who have bid up stocks in anticipation of some huge profit surge. This is assuming everything goes according to plan and the U.S. economy grows strongly in 2024, which is probably too optimistic. This assumes everything goes right– if you assume the P/E multiple holds steady at 20x you get a forecast of 4340 for year-end 2024.

A more realistic forecast would account for the chaos that printing money wracked on the U.S. economy. Interest rates have skyrocketed and inflation remains too high, meaning that many of the drivers for corporate profit growth have now reversed. Companies will steadily have to refinance their old debt at much higher interest rates, eating into profits over time. There's no plausible way that interest rates can go down enough to stop this. No matter if the Fed pivots or not, companies aren't getting 1.5% bonds anymore, and will be refinancing all expiring debt at rates 4% or more above their old rates. This will slowly correct the above-trend growth in profits that arose from zero-interest-rate Fed policy.

Also, note that GDP can tend to overstate the economy's strength. Construction is fed into GDP bit by bit as it's completed, but if the construction being done doesn't result in much income for the economy then you won't see a recession in the data until it's too late. Empty office buildings or giant vacant developments of housing in the swamp count as GDP, but they produce no income for the economy. I think you're better off using GNI (gross national income) in this case, in which case we get an earnings forecast of about $200 for the S&P 500 and a forecast of 4000 for the index. GNI hasn't grown as fast as GDP, highlighting the gap between how Americans are feeling about the economy and what official statistics are indicating that don't account for dwindling savings or the use of credit.

Also, it's important to note that the U.S. economy is actually likely to struggle to put up strong growth numbers in 2024. People like to joke about leading economic indicators predicting nine of the last two recessions, but if you actually go back and look at historical data, the leading indicators are never wrongly predicting a recession. Every time the leading indicators deteriorate past a certain point, a recession follows. Also, the deeper the fall in leading indicators, the deeper the recession tends to be.

A recessionary figure for earnings might be closer to $180, which would imply a ton of downside for stocks. After all, there are hundreds of zombie companies that have been on life support with years of free money. These companies are likely to fail, lay off their employees, and restart the business cycle so the resources they're taking up can be allocated elsewhere. That's how capitalism works– even the USSR had business cycles– if you think the Democrats or Republicans can stop the business cycle from happening by printing money then you'd be mistaken.

I'll split the difference between the recession I see happening and the rosy forecast of Wall Street and land on an overall forecast for the S&P 500 earnings of $200. On earnings alone, the index could be anywhere from 2000 in a 2008-panic scenario to 5000 in a 1999-style euphoria. However, finding a fair value for P/E ratios is actually easier than you think because you can use interest rates to guide you. And the data tells us P/E ratios are too high.

S&P 500 P/E Forecast

As I mentioned before, the long-run average PE ratio of the S&P 500 is about 16x. But this includes times when the cash rate was nearly 20% in the early 1980s as well as when it was at 0% after 2008. There are various ways to ballpark a P/E ratio for stocks, such as the "rule of 20" or by running a linear regression on past interest rates. The rule of 20 says to take 20 minus the inflation rate to get a fair PE ratio for stocks.

What I think is better is to run a linear regression on yields vs. stocks. I like this much better because interest rates actually offer an alternative to stocks.

We can see here there's a strong correlation. If we grab some longer-term data, we can get an estimate for a fair P/E on the S&P of somewhere between 14 to 18x.

This isn't an exact science, but the P/E multiple for the S&P 500 is clearly out of line. This graph predates the monster rally over the past few weeks so the multiple was only 19x then. To get back to fair value from a P/E perspective, the mega-rally over the past few weeks needs to be reversed, plus another 10% or more on top of it. 21x is not a normal P/E ratio, implying a lot of hype built into tech that's skewing the entire stock market. I'll give some credit to tech by taking some of the lowest P/E ratios out, but we shouldn't just assume that tech will drive huge earnings gains when long-running research by the Fed clearly tells us that tax cuts and interest rates were the key drivers of the bull market, not the innovations of giant tech companies. Much of Big Tech's success has come from colluding not to compete, not a radical pace of innovation. Remember that 100 years ago, there were no interstates, no TV, and the airline industry was in its infancy. Now we have 100-story skyscrapers and calculators in our pocket that can call across the world and look up anything on the internet on command.

Yet, the average P/E multiple for stocks was 16x over this time, and investors who paid huge multiples were nearly always punished. AI is a great technological innovation, but it's been around for years and can't really be controlled by a single company. To assume that AI will be like long-distance telephone calls were in the 20th century with monopoly profits to one or two companies doesn't make much sense. A better model is like FaceTime Audio and WhatsApp today, allowing you to call whoever you want anywhere in the world for free, while no company makes much money off them. In many cases, technology didn't increase profit margins for Corporate America, it actually had little effect or decreased them. Cathie Wood's deflation calls are a little out there, but it's not actually crazy to think that AI might cause corporate profit margins to decrease.

Plugging in earnings of $200 and a P/E ratio of 16x gets me a fair value estimate for the S&P 500 of 3200. Plugging in 17.5x gets me 3500. Therefore, my forecast for the S&P is to finish the year somewhere between 3200 and 3500. I had a similar but somewhat lower forecast for last year, this year I'm revising it up a little because the economy has grown a bit bigger. The amount of overvaluation in stocks has grown, largely due to the hype around AI and Ozempic. It's not hard to imagine stocks going much lower, for example, $180 in earnings and a 15x PE lead to the index bottoming out at 2700. Investors have panicked much worse than that in the past, and hitting 2400 on the S&P 500 would not be historically unusual for an all-out bear market panic. If an extreme scenario like the S&P 500 hitting 2400 happens, you can safely go all-in on stocks. Stocks still need a catalyst to fall, but with lending slowly drying up and leading economic indicators falling, it's a matter of time before something breaks.

2024 Wildcard: The U.S. Presidential Election

Now, let's talk politics. The bookies think 2024 will be a rematch between former president Donald Trump and current president Joe Biden.

Trump is roughly a 75% favorite to be the GOP nominee, with Nikki Haley in a distant second place with 18% odds. Joe Biden has slightly worse odds to be the Democrat nominee at 68%, with California governor Gavin Newsom favored by bookies as the second most likely at 23%.

Overall, the single most likely person to be the next president of the US is Donald Trump, though Newsom and Biden combine to make Trump an underdog against the Democrats. Trump has a huge pull in the US, and the unwritten reason why he has so much control over the Republican party is that he can run as a third-party candidate and wreck the party's chances of the presidency if he doesn't get the nomination. Polls are showing that Nikki Haley is more likely to defeat Biden, but Trump has more power in the primaries because of his base. In a weird way, the dysfunctional two-party primary system is likely to deny Republicans their chance at retaking the White House by forcing Republicans to nominate Trump, lest he blow up the election out of spite. Ross Perot's run in 1992 was the last time that a serious third-party candidate ran for President. Perot picked up 18.9% of the vote. Despite what the party said at the time to cover their butts, Perot cost Bush the presidency and allowed Bill Clinton to cruise to the White House.

If Trump is the nominee, Biden will likely win, or Gavin Newsom in his place with a similar electoral map to 2020. This isn't set in stone, but it's more likely than not. If Haley is the nominee, she'll lose if Trump runs as a third-party candidate, splitting the vote and handing the election to the Democrats. If Haley runs and Trump doesn't run, Haley will likely win. The real wild card here is if West Virginia Senator Joe Manchin and Donald Trump both run as third-party candidates, splitting both the Democrat and Republican votes. Control of Congress is likely to stay divided, in large part due to the 2020 Census which helped cement Republican control over large parts of the process of drawing congressional districts. This will make it harder for Democrats to keep the House, and the Senate map is also highly favorable for Republicans. When next November's election is over, my best guess is that the Democrats will narrowly win the presidency, while Republicans will take control of Congress. Overall, the Democrats are about 56% to keep the White House.

We don't know for sure what will happen with the election, but we do know that the Trump tax cuts are set to expire at the end of 2025. If Democrats sweep the elections, corporate tax rates are likely to rise significantly, as well as capital gains taxes and income taxes. High earners in states like California could see their marginal income tax rates hit the 60% to 70% range, up from the current top rate of ~54% (37% Federal income tax + 3.8% Medicare surcharge +13.3% CA state tax). This scenario would increase demand for municipal bonds as well as more complex tax shelters. A split government is likely the best scenario for stocks, while Trump 2.0 may lead to well-founded fears over more inflation and money printing.

Bottom Line

2023's success for the stock market was largely about what didn't happen after markets priced an imminent recession in the fall of 2022. 2024's failure may also hinge on what doesn't happen, in the form of dreamy earnings estimates not being hit. The Fed has continued its hiking campaign, and leading economic indicators continue to weaken. With stocks trading for unusually high valuations, returns going forward are likely to be unusually low. Whether this plays out with 5-10 years of a see-sawing, sideways market or a crash is yet to be seen. Earnings estimates in 2024 are likely to disappoint, as well as the returns of the stock market. In light of these, I'm updating my range of forecast for the S&P 500 to 3200 to 3500, with a midpoint of 3350 serving as my prediction for where the S&P ends 2024. Stocks can and likely would go lower in a panic.

“Editor's Note: This article was submitted as part of Seeking Alpha's 2024 Market Prediction competition, which runs through December 20. With cash prizes, this competition -- open to all contributors -- is one you don't want to miss. If you are interested in becoming a contributor and taking part in the competition, click here to find out more and submit your article today!”

Logan Kane