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The story of 2023 was the recession that never was and the end of the interest rate hiking cycle. Corporate earnings growth beat expectations, and the S&P 500 saw a 26 percent return. And in the first half of 2024, that upward trajectory largely continued. Large-cap stocks have led the way, while mid- and small-caps have lagged. Value stocks have underperformed growth stocks, with higher earnings growth for growth stocks keeping them in the lead.
Looking ahead, the tug-of-war between earnings growth and valuations will be a key theme for the second half of 2024. According to FactSet consensus estimates as of May 31, 2024, S&P 500 earnings could rise 9.2 percent in the second quarter and 8.3 percent in the third quarter. Fourth-quarter earnings (reported in 2025) will be a major factor in valuations, where the expectations call for 17.5 percent growth. Combined with expectations for 14 percent growth for 2025, this could support equity valuations despite their elevated level of more than 20x forward earnings expectations.
Greater Market Balance In Sight?
Assuming that earnings align with expectations and there is no change in multiples, we could see close to double-digit percentage growth in the price of the S&P 500 for the second half of 2024. But the path upward is not without obstacles. Market concentration in both market capitalization and earnings sources has raised risks.
The Magnificent Seven tech giants have powered much of the S&P 500 earnings growth in recent years, benefiting from rising spending in artificial intelligence (AI). As this cycle of tech spending peaks, other areas of the market may see increased growth on the productivity gains that come with the investment in technology.
S&P 500 Earnings Projections Find More Even Footing
Source: J.P. Morgan Guide to the Markets, as of May 31, 2024
After steep inflation allowed companies to hike prices to defend earnings, the next climb will be cost control and margin expansion as inflation cools. While supply chains have improved and wage growth has slowed, a tight labor market or weakening consumer spending could create headwinds for earnings. Margins have expanded so far in 2024 but are already above historical averages, making further significant gains a challenging hill to climb.
What Will Elevated Valuations Mean for Equity Outlook?
While S&P 500 growth projections are high, valuations are also well above historical averages. Higher valuations typically lead to lower returns over longer periods. The largest companies are pulling double duty: driving earnings growth and high valuations.
The top 10 companies have achieved valuations far above their historical averages, while the rest of the index is closer to average. Small- and mid-cap companies are also closer to long-term average valuations, despite higher long-term growth expectations.
Widening Valuation Gap in the S&P 500
Source: J.P. Morgan Guide to the Markets, as of May 31, 2024
This dynamic extends to the international space, where equities are priced below historical averages compared to the U.S.
Global Shares at Steep Discount to U.S. Peers
Source: J.P. Morgan Guide to the Markets, as of May 31, 2024
Valuations have been getting cheaper for international stocks for the past 15 years, but a shift in the landscape may be coming. A rebound in consumer spending abroad, where consumer discretionary companies are trading at nearly a 50 percent discount to U.S. firms, could drive a rebound in equity prices.
Expectations for 2024 (and Beyond)
Today's leaders won't remain on top indefinitely. Investment in AI and strong consumer and business spending have continued to fuel the Magnificent Seven's ascent, but companies with lower valuations will eventually make moves to overtake current leaders.
For now, the growth outlook supports some of the more expensively valued firms. As the year moves along, valuations may decline as it becomes more difficult to maintain high compounded growth rates.
Given the expectations for elevated growth and a modest decline in valuations, we still see the S&P 500 continuing to rise in the second half of 2024. But for the climb to extend into 2025, smaller-cap and international stocks must help carry the load.
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