The S&P 500 has shifted to a slower pace, departing from its rapid gains seen since early April. As of now, it has risen 12.3% year-to-date, aligning with the average year-end performance over the past decade. The index reached a record high of 6890.59 on October 29, coming close to an initial year-end target of 7000, which is now more likely to be achieved early next year. The long-term target has been raised to 7700 by the end of next year.
There are signs that while the enthusiasm surrounding AI is not collapsing, it is experiencing a significant cooling, a development that could enhance the durability of the current bull market, which began on October 12, 2022. The broad market, as measured by the equal-weighted S&P 500, has returned to its 200-day moving average, a level analysts do not expect to fall below. Conversely, the market-capitalization-weighted S&P 500 remains 7.2% above its 200-day moving average, with expectations they will not test this level.
The Nasdaq Composite is also showing resilience, up 15.3% year-to-date, closely mirroring its historical average for this time of year. However, market observers are wary that the ongoing pullback could develop into a more significant correction, defined as a drop of 10% to 20% from recent peaks. Confidence among investors has waned, particularly concerning the ability to forecast the financials of companies heavily reliant on GPU chips.
As a result, the forward price-to-earnings (P/E) ratio for the “Magnificent-7,” which includes major hyperscalers, has seen a decline from 31.0 to 28.1 since late October. There is speculation that further downside could be possible in this multiple. Additionally, the recent slump in bitcoin prices has contributed to the stock market’s volatility, given that many bitcoin investors also tend to hold high-growth stocks. Expectations are that once the panic selling abates, a recovery in the stock market could unfold over the next few weeks, potentially setting the stage for a year-end rally.
Despite short-term valuation concerns, the underlying strength in S&P 500 earnings remains robust. Over the previous three quarters, earnings growth has exceeded analysts’ consensus estimates by nearly twofold. Forward earnings for the S&P 500 continue to rise, likely converging with the analysts’ consensus estimate for 2026, projected at $309.28.
However, there are challenges to this optimistic earnings narrative, particularly regarding the major companies in the “Magnificent-7.” Their significant contributions to overall market strength have been driven by extending the depreciation period for GPU chips beyond the standard accounting practices, raising questions about the sustainability of such earnings. This issue remains contentious, creating a “known unknown” for investors. Conversely, earnings from the remaining companies in the S&P 500, dubbed the “Impressive-493,” continue their upward trajectory, supporting the overall market.
In contrast, the S&P 400 MidCaps and S&P 600 SmallCaps have reported less impressive forward earnings, partly due to their tendency to be acquired by larger companies before they reach their potential as independent entities.
The resilience of the economy remains a focal point, underlined by strong earnings growth. Recent business surveys indicate a possible rebound in national manufacturing metrics, suggesting positive economic momentum. Concurrent discussions among Federal Reserve officials regarding federal funds rate adjustments are ongoing, with doves expressing concern over rising unemployment while hawks remain focused on persistent inflation levels exceeding the Fed’s long-term targets.
Recent market activity has shown a notable rotation out of sectors like Information Technology and Consumer Discretionary, toward Health Care and Consumer Staples. Analysts are currently leaning towards an overweight position in Health Care, maintaining market-weight in Information Technology and Communications Services. Investment experts continue to monitor these shifts as they assess the broader market landscape.
