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Wall Street expects the stock market to earn a return in 2025 that is similar to the average return over the past 100 years. Do you agree?
Forbes, Reuters and others report that Wall Street expects a 10% return on U.S. stocks in 2025, with a range between 8% and 12%, aligning with average returns in the past. Unpacking these estimates reveals an expectation that the market’s price/earnings ratio will remain the same next year as it is now.
Framework
There’s a framework for turning your P/E expectation into a return forecast. The following formula is always correct because it is a tautology. To predict the future, simply estimate earnings growth and P/E expansion or contraction, which is driven by investor behavior:
Return = Dividend Yield + (1 + Earnings Growth) X (1 + P/E expansion/contraction) – 1
So, what if P/Es contract, regressing to historically more normal levels? As shown in the following table, in that case, stock markets would likely correct in 2025, with an average estimated loss of 30%.
Your forecast
Is Wall Street gaslighting us because they want us to stay in the market? Where do you see P/Es a year from now? You can look up your expected P/E row in the table above. Note that the Earnings Growth columns don’t change the forecast much. However, you can find your column and note what the corresponding cell holds as your forecast. Does the expected result make sense to you?
Future P/Es
The U.S. stock market is currently expensive by every measure. Of course, it could become even more expensive. Justifications for the current high price include:
- Low interest rates cause discounted future earnings to be high;
- The stock market is an inflation hedge;
- Artificial Intelligence is the new dot-com, promising a rosy future; and
- The Trump presidency is good for the stock market.
On the negative side, the current exuberance is building to a Minsky Moment that could cause the market to crash under its own weight – plus, there are plenty of potential catalysts like war, inflation, geopolitics, etc.
Your forecast reflects your outlook for expensiveness. Do you expect more of the same or regression toward the mean?
Baby boomer warning
Forecasting is a critical step in market timing, which is very difficult to do correctly. But risk management for baby boomers is much easier. That’s why my “Revenge of the Baby Boomers” article got 80,000 reads on SeekingAlpha.
Baby boomers cannot afford losses at this time in their lives. They might not live long enough to recover, and their lifestyles could be dramatically reduced. That group should be protecting their lifetime savings right now. I’ve recommended they consider TIPS and inflation-protected equities like natural resources and precious metals. Everyone else, beware.
Ron Surz is president of Target Date Solutions, developer of the patented Safe Landing Glide Path and Soteria personalized target date accounts. He is also co-host of the Baby Boomer Investing Show. Surz’s passion is helping his fellow baby boomers at this critical time in their lives when they are relying on their lifetime savings to support a retirement with dignity, so he wrote a book, “Baby Boomer Investing in the Perilous 2020s,” and he provides a financial educational curriculum.
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Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.
