Equity market outlook for 2025 and 2026

Given our optimistic take for the markets on the recent Trump landslide election (Playing chess versus checkers), along with the fast approaching new year, clients are asking about our new forward price target on the S&P 500. The short answer is "more of the same." Here is the quick summary:

We are introducing a two-year target on the S&P 500 of 7,500 for year-end 2026 and raising our year-end 2025 target from 6,000 to 7,000. We continue to expect the broader market to perform well in 2025, and remain overweight stocks versus bonds and within stocks, tilted in our balanced portfolios toward large-cap value and small-cap stocks, while maintaining significant, though modestly underweight, positions in large-cap growth as well. Our international allocation is tilted toward emerging markets rather than developed markets in Europe and Japan. Our reasoning is as follows:

1. The US economy is on solid footing, with inflation declining, the Federal Reserve cutting rates and the yield curve re-inverting. We view the Trump agenda, on balance, as dis-inflationary, despite some potential for price pressures from tariffs. The government productivity/cost-cutting drive, deregulation of the private sector and increased domestic production of oil and natural gas, are all dis-inflationary and should more than offset whatever tariffs result from the trade negotiations, which should be net US-positive, in any case. A potential peace dividend from settlement of the foreign wars would also help here. With inflation stabilizing at or below 2.5% (where it is near now), the Fed has more room to cut and will likely do so gradually. We expect the fed funds rate to settle at 3.0% sometime in 2026, with the 10-year yield stabilizing around the 4.0% level. Although the path for getting there is likely to be volatile, as bond markets potentially over-react to near-term developments, on a two-year view, this trend is equity market and valuation supportive.
2. Given the conclusive outcome of the 2024 election, we anticipate a relatively quick implementation of Trump's pro-growth agenda. This agenda includes lower corporate tax rates and, as a minimum, no hike in personal tax rates, including no hike in the higher bracket rates that impact many of the more than 33 million small businesses in the country. In addition, we expect a substantially lower government regulatory burden, along with the new government efficiency drive led by the newly created Department of Government Efficiency, to improve economic productivity and growth. Trade policy is likely to raise in-bound US investments and improve exports for US corporations; declining trade deficits will also, by definition, increase US GDP. All of these agenda items should not only improve economic growth, but also nominal corporate profits to $350 in 2027.
3. Once interest rates stabilize at lower levels, we think the valuation on the S&P 500 can expand to a level around 21.5x forward earnings. This multiple, though historically high, is really a blended valuation target based on a more normal 18 multiple on the broad market, excluding the mega-cap US growth companies, which can and should trade at a substantially higher premium given their solid long-term fundamentals and relatively asset-light business models.
4. Developed economies in Europe and Japan likely to be the biggest losers. Trump's economic agenda will prioritize domestic US growth over foreign economies' exports to the US. Defense spending is likely to rise overseas and limit Europe and Japan from countervailing fiscal-stimulus measures. And the major engine of this leg of the bull market, the AI revolution, is centered in the US powerhouses that comprise the Magnificent Seven. Emerging markets are likely to benefit from cheap valuations, domestic stimulus measures to offset rising US tariffs and a larger weight in growing technology stocks.

As noted above, we continue to lean into the broadening out of the market and the sectors most likely to benefit from this: value, cyclicals and small cap (growth and value.) As the chess game plays out, we do expect market volatility around headline risk as Trump and his government stake out initial positions, which on the surface may appear market unfriendly, and/or as foreign governments react initially to those positions. We are keeping a small amount of cash aside in our balanced funds, funded by our underweight to bonds, for the purpose of adding further to equities on any pullbacks. In the meantime, we continue to remain overweight stocks in all balanced portfolios. Internationally, we are keeping our portfolios tilted towards the cheaper and faster growing emerging markets over developed ones.