At the end of 2024, many commentators claimed that U.S. stocks were overvalued, with the S&P 500, the Dow Jones Index, and the NASDAQ Index reaching record levels. The trailing P/E for the S&P 500 stood at 28.2 and the forward P/E at 23.6 relative to an average of 22.8 and 19.1 respectively at December 31 in the past two years. A common expected return for 2025 by commentators was 6. However, Goldman Sachs forecasted that the return to U.S, stocks over the next 10 years would be an average of only 3% per year. Bank of America forecasted zero to 1% annually. Is the market “peak passive”?
Chapter 8 provides a way of estimating the future return on the market and that has proved to be a good predictor of actual returns. So let’s look at the S&P 500 price at the end of 2024 when the index stood at 5881.63, having risen 25.02% (total return) for 2024.
The inputs:
Forward ROE = 20.2% (estimate as of December 31)
Book-to-price = 0.211(estimate)
Expected GDP annual growth rate = 3%
Applying the ER formula,
ER = [0.211×20.2%]+[0.789×3%]
= 4.262% + 2.367
= 6.63%
Chapter 8 reports that the estimated ER for the S&P 500 has been correlated 0.27 with returns over the subsequent year. Here are the ER at December 31in previous years with a 3% GDP growth rate, along with the subsequent return over the next year for the index:
| 2021 | 2022 | 2023 | |
|---|---|---|---|
| S&P 500 | 4766.18 | 3839.50 | 4769.83 |
| ER | 6.79% | 7.45% | 7.49% |
| One-year return | -18.11% | 26.29% | 25.02% |
ER is an estimate of the annual return over a very long horizon for which the index is priced, so small difference amount the large compounded differences over time.
Trailing earnings, forward earnings, book values, and dividends are those at December 31 complied by S&P Global at https://www.spglobal.com/spdji/en/indices/equity/sp-500/#overview.