Progress, But Further Mean Reversion Could Be in Store

Earnings estimates for the S&P 500 continue to fall.  The consensus estimates for 2025 and 2026 have now dropped over 4% from their respective highs in mid-2024.  These may not seem like big decreases, and they really aren’t.  The current estimates are still assuming that S&P 500 earnings will grow 10.7% in 2025 and another 14.1% in 2026.   Those growth rates are well above long-term historical averages, and they seem to reflect an unusual amount of optimism (irrational exuberance?) given the extraordinary amount of policy uncertainty that exists.  The economists that submit these earnings projections appear to be assuming a speedy resolution to the trade wars as well as follow-through on promises for large tax cuts and regulatory reform.

The next chart shows the deceleration in 2025 earnings growth for the S&P 500 as well as the price-to-earnings (P/E) ratio for the index.  You will see that the P/E ratio has been falling, from a month-end high of 22.4x in January of this year to 20.3x as of April 15th.  The drop in P/E ratio has been occurring even as earnings estimates have been falling at the same time.  The translation is that the index level, which is the ‘P’ in the P/E ratio, has dropped more than the ~4% downward revision to the 2025 earnings estimate (the ‘E’ in the ratio).  Indeed, the S&P 500 is now down over 12% from its all-time high on February 19th of this year (through April 15th) – far in excess of the 4% downward revision to 2025 and 2026 consensus earnings estimates.   

If you believe that earnings estimates have further to fall in the absence of a swift, comprehensive and definitive trade deal with numerous trade partners, then stock prices could have significantly more downside. But herein lies the rub: we have absolutely no way to predict whether these trade disputes will be resolved tomorrow, in six months, or not at all.  And in the absence of any transparency with regard to trade policy, investors are likely to keep reducing risk in their portfolios.  At this point, it’s unlikely that incremental progress over a period of months will be enough to re-instill investor confidence.

Despite the initial positive reaction to last month’s elections, we knew this transition would be a difficult one.  Investors simply do not like uncertainty in the form of unpredictable economic policies.  The administration’s scattershot approach to governance is finally taking its toll, and we’re not sure how to get the genie back into the bottle.  That said, President Trump has again reinforced the notion that he will respond to sharp capital markets volatility.  As the bond and stock markets dropped sharply last week, the president stepped in with a 90-day pause in the draconian reciprocal tariffs he announced only days previous.  Based on that move, it appears as though a 20% drawdown in the stock market and a 4.5% level on the 10-year Treasury note are levels that he will defend if necessary.  Nobody likes to hang their hat on something like that, but that’s where we are right now.

Hang in there.  I continue to believe that the draconian tariffs that were suspended for 90 days won’t see the light of day again.  They are simply too destructive to the global economy.  Dramatically watered down versions are likely in store but, as noted, the timing is highly uncertain.  As hard as it is at times, investors must maintain their discipline and drown out the daily noise and gyrations as this process continues to unfold.