By Kenneth N. Green, CPA, MBA
Like most people, I am glad that the election is behind us if only because we can turn on the radio and television sets and not have to listen to campaign commercials! Donald J. Trump is the 47th President of the United States, the Senate is in Republican control with a 53-47 margin, and the House of Representatives is also in Republican control with a 219-213 majority with Republicans having picked up just one seat. This is certain to change the direction of economic policy toward pro-growth, and less regulation. It is too early to forecast how the potential changes will impact inflation, job growth and economic growth. And, the impact on interest rates going forward is also uncertain.
The new administration’s first order of economic business will be introducing a series of broader and higher tariffs in an effort to produce reshoring and economic growth. The goal here is to protect and boost domestic manufacturing and use the accompanying revenues to reduce the federal deficit. Next, Elon Musk will be in charge of the Department of Government Efficiency (DOGE) in an effort to target wasteful spending. Mr. Trump campaigned on a series of targeted tax breaks for corporations and individuals. These include tax cuts for tips, social security, and overtime. Interestingly, these include nearly every working American. Also, the tax cuts from 2017, currently scheduled to expire next year, may be extended permanently. In an effort to lower energy costs, the Trump administration will relax restrictions on oil drilling and mineral mining.
Now that the Republicans will have control of both houses of Congress, Mr. Trump will have two years to pass his major legislative objectives. The party in power usually loses congressional seats in the mid-term elections. For now, we think the chief factor for markets is this: Uncertainty is falling and this should be a tailwind for the stock market through yearend. Markets are party-blind, with no preference for Democrats or Republicans. Markets care about policies and whether legislative risk is higher than expected. Falling uncertainty has aided bull markets under both parties while new major legislation has brought bear markets under both.
Since 1925, when the election doesn’t occur during a pre-existing bear market (i.e. 2008), the S&P 500’s average price return between the election and yearend is 3.6%. This is not a prediction as averages are a blend of extremes. Still, the awareness has some value.
It is premature to predict what Trump’s policies will mean for markets, although investment firms of every kind will try to tell you what their chief investment gurus are predicting. This mostly serves their marketing efforts in gathering assets. Right now, there are fears of sweeping tariffs and hopes for tax cuts. We cannot know now which provisions of 2017’s Tax Cuts and Jobs Act will get extended, whether tax rates will fall further, and whether the state and local tax deduction will return. We do know, however that tax changes have no preset market impact. Any blanket tariffs would require congressional approval and even these could not be imposed on countries such as Canada and Mexico with whom we have existing trade agreements i.e., NAFTA.
Bond markets have been less enthused with Trump’s win. As we write, the 10-year Treasury note is at 4.43%, up from 4.04% just one month ago and 3.62% just two months ago! This reflects the common view that Trump’s presidency will come with higher debt and inflation. And, this occurred since the Fed started cutting short-term rates in September.
30-year fixed mortgage rates peaked around 7.8% in October 20023. It is this rate that impacts US housing market activity. Given how important this sector is to most of us, many pundits are inclined to overrate its economic significance. Residential real estate is a tiny slice of US GDP, around 3-5%. Hence, we believe it would be a mistake to overrate its economic or its market influence.
Since mortgage rates peaked one year ago, sellers became reluctant to abandon their existing 3-5% mortgage for a higher rate. Hence, the supply of existing homes for sale dried up and this sent prices higher. Normally this should spur new construction. However, the higher prices combined with the higher rates have deterred new homebuyers. The supply of homes available for sale is very tight and more families are competing for a limited supply of rental units. How we get off this hamster wheel remains to be determined.
Although US stocks fell alongside housing activity in 2022, they recovered in 2023, rising 26.3% despite housing’s continued weakness. Whatever happens with housing, stocks and GDP can do well. In Q4 2022, residential real estate fell -22.8% annualized. This detracted just 1.1 percentage point from GDP growth. When residential real estate grew 13.7% in Q1 2024, it added just a half point to GDP. A big movement in a small industry tends to have a minimal impact overall. As residential real estate contracted over the last two quarters, US stocks advanced 10.4%. If housing market weakness were an indicator for broad economic pain, we doubt that stocks would be near all-time highs.
Based on our outlook for continued economic growth through 2025, we have raised our 2025 and 2026 forecasts for S&P 500 earnings from continuing operations to $276 from $265, and to $307 from $285 respectively. That includes mid-single digit growth in Energy sector earnings, and low double-digit growth in the Materials and Industrials sectors. These three sectors reported negative year-over-year earnings in the just completed third quarter. We also look for continued double-digit growth in the largest sectors, Communication Services, Technology, Healthcare, and Consumer Discretionary. We expect the Artificial Intelligence transformation to continue to drive growth in these large sectors. We look for subdued growth in Consumer Staples and Utilities.
We have a year-end 2025 target price for the S&P 500 of 6,585, representing a 10% price appreciation from the 5,969 level as we write today. Our new target incorporates fundamental, technical, and historical considerations, influenced by 2.4% projected growth in U.S. real GDP and the aforementioned EPS growth. This is supported by a continued decline in inflation readings and interest rates. Tempering this optimism are the historical returns during third years of bull markets and following two successive years of double-digit increases, combined with stretched valuations relative to 10-year averages. We also project elevated volatility as nearly 90% of the first years of presidential terms since 1949 endured declines in excess of -5% and averaging -17.5%. As we said this past May, technically, the outlook for stocks remains bullish as most indices are at new all-time highs and market breath has been widening. Historically, this has meant further gains over the ensuing six to twelve months. All-time highs are usually bullish, at least until we come to the last one.
Ken Green is the Senior Vice President and Director of Investments at Marc J. Lane & Company, the investment affiliate of The Law Offices of Marc J. Lane, P.C.
If you would like to discuss your investment strategy in confidence, please reach out Marc Lane at 312/800-3721040 or mlane@marcjlane.com.