The rise of the S&P 500 index is supposed to reflect the performance of a diversified group of stocks and sectors. But since the 2010s, it's been more like a Big 7 index, with its rise driven by the most powerful, primarily tech companies. In 2024, the Magnificent 7 -Apple, NVIDIA, Microsoft, Alphabet, Amazon, Meta Platforms and Tesla - accounted for more than half of the index's gains.
The index has delivered annual returns of approximately 25% in the last two years. If this growth rate holds up, investors could potentially double their dollars every three years by investing in one of the S&P 500 ETFs. According to Trendlyne, returns were even higher for growth or momentum ETFs, some of which delivered over 35% returns in 2024.
But now, analysts are waiting for the other shoe to drop. Valuations have ballooned, especially for the Magnificent 7, while revenues in promising new areas have failed to materialize. Even superstar investorWarren Buffet has increased cash reserves significantly to over $300 billion, around 28% of total assets.
Volatility worries are also turning up in analyst reports. Donald Trump, the incoming US President, with his all-caps social media pronouncements ("TIKTOK IS LESS OF A DANGER TO THE USA THAN META (FACEBOOK!), WHICH IS A TRUE ENEMY OF THE PEOPLE"), and his impulsiveness, makes market watchers nervous. The S&P 500 is trading at a discount of around 3% from its December high, ahead of Trump's swearing in on January 20.
Commenting on long-term treasury yields nearing 5% levels, Torsten Slok, Chief Economist at Apollo Global, said, “80% of the increase in long rates since September has been driven by worries about fiscal policy (under Trump).” The Trump administration is likely to give analysts at least a few sleepless nights this year.
AI was in the driver's seat in 2024. What happens now?
More than 40% of companies in the index mentioned “AI” during earnings calls as they race to stay competitive in this once in a generation technology shift. NVIDIA, a leading player in AI chips, saw its valuation nearly triple in one year.
According to a Citigroup report on AI, more than half (54%) of the jobs in the finance sector have a high potential for automation. Other sectors with significant automation potential include insurance (48%), energy (43%), capital markets (40%), and travel (38%).
The Mag 7 drove gains for the S&P 500 in 2024. But AI for all its hype, has yet to deliver the money. The 2025 outlook for big tech is less rosy, with rising expenses and little to no return from AI-based services so far. Trendlyne’s Forecaster predicts a modest 7.3% median upside for the Mag 7 in 2025, a notable decline from the median return of over 50% in 2024.
Mag 7’s share of S&P 500 market cap has tripled over the past decade
The winners: semiconductors, healthcare, pharma led industry performance in 2024
Over the past year, semiconductors, electronic equipment, healthcare services, specialty pharma and airlines were the top performers, soaring 70% and more. Semiconductor and electronic equipment companies were fueled by the growing demand for AI applications, 5G networks, and the Internet of Things (IoT), while airline companies benefitted from more travel. Tourists were getting sprayed with water in Barcelona, and the normally mild Japanese were complaining about local transport services being overwhelmed. But tourist traffic kept growing.
Healthcare services and specialty pharma also witnessed strong growth, rising by 73.5% and 70.3%, respectively, over the past year.
Semiconductors lead with a 93.8% rise, while oil, steel, and discount retailers lag
On the other hand, discount retailers, alcoholic beverages, and steel were among the laggards. Companies like Dollar Tree and Five Below were impacted due to slower consumer spending.
In 2021, the average American over 21 consumed alcohol in an amount equivalent to over 600 standard drinks. But recent state health warnings, and shifts in behavior towards non-alcoholic drinks among younger Americans, is hurting the alcohol industry. Meanwhile, cable/ satellite and steel industries declined by over 13% in the past year.
Analysts predict modest gains for the S&P 500 in 2025
For 2025, the median forecast for S&P hints at a modest outlook, with the index projected to reach 6,600, an 8.2% return. Wells Fargo's high estimate points to a 14% return, while UBS' conservative estimate suggests only a 5% gain. Interestingly, no forecasts predict a negative return for the year.
Wells Fargo predicts street high S&P 500 target of 7,007 for 2025
Goldman Sachs highlights the correlation between corporate revenue growth and nominal GDP growth, saying, “Corporate revenue growth (at the index level) typically moves in line with nominal GDP growth. Our estimate of 5% sales growth for the S&P 500 is consistent with our forecasts for 2.5% real GDP growth and for inflation to cool to 2.4% by the end of next year.”
The incoming Trump presidency could shake up markets with tax cuts, tariffs, and deregulation
From Trump’s inauguration in 2017 to his final day in office, the S&P 500 rose at a CAGR of 13.8%. This was a significant rise even with the pandemic selloff in March 2020, which saw the market’s worst period in decades. Trump’s 2024 re-election can mean more action on tariffs, deportations, deregulation, and tax cuts.
Trump’s 2017 tax cuts increased deficits, with the US trade deficit rising by 41.2% between 2016-2020, the highest since 2008. If Trump's new tax plans are implemented as expected, US debt might rise to 141% of GDP by 2034, compared to 134% without any policy changes. If all his tax promises are fulfilled, debt could increase even more, reaching 150% of GDP.
The stricter immigration rules Trump wants may reduce the labor supply, affecting sectors like hospitality, agriculture, and technology, which rely heavily on foreign labor. Companies reliant on Chinese imports could see a rise in raw material costs with tariffs, which may squeeze profit margins, particularly in the technology, consumer electronics, and manufacturing sectors. But relaxed antitrust regulations may boost mergers, especially in tech, healthcare, and energy.
Trump is promising big changes. The road from promises to policies however, is long and arduous, especially with the thin majorities the Republicans have in the House and Senate.
