S&P 500 Index to make only small gains over the next few years – CE

The rally in the S&P 500 has lost some steam lately. Economists at Capital Economics expect the S&P 500 to make only small gains over the next few years. Nonetheless, they think some sectors – such as financials – will continue to do better than the index as a whole.

Earnings expectations and the outlook for the S&P 500

“We don’t expect the index to resume its rapid gains any time soon. The boost from higher valuations it received last year has, in our view, largely run its course. Indeed, we expect real long-dated Treasury yields will rise over the next two years, which would prove a drag on the valuation of the stock market. And we doubt there is much scope for risk premia to narrow much further to compensate either. As such, we suspect further gains in the S&P 500 will have to come from earnings growth.”

“A significant degree of optimism about earnings looks to be already discounted. Analysts now expect ~35% YoY earnings growth for S&P 500 companies as a whole in 2021, and still above-average growth even in subsequent years. This would represent a faster recovery in earnings than after the Global Financial Crisis, despite having fallen less during the pandemic than they did then. As such, we doubt there is much scope for further positive earnings surprises to boost the stock market overall.”

“As the recovery from the pandemic has progressed, expectations for the earnings of the hardest-hit sectors of the stock market – such as financials – have steadily been revised up relative to those that were less affected, such as IT. Despite these cumulative revisions, we suspect there is still room for the gap in expected earnings of these sectors to close further as the economy continues to recover. So we wouldn’t be surprised if the rotation trade continues a bit longer.”

“We forecast the S&P 500 index to reach 4,700 by end-2023, which would represent an annualised gain of ~4%, compared with ~40% over the past twelve months and ~12% over the past decade.”