We raised our 2025 S&P 500 Index target to 7,000 from 6,600 on election night, as we expected the Trump mandate to allow for a cut in the corporate tax rate to 18% as a potential compromise with Congress. It now appears that the Senate will have up to 53 Republicans and that the Republicans will retain control of the House. If no compromise with a Democratic house is required, we will likely end up with a corporate rate closer to 15%, as President Trump has proposed. In that case, our S&P target would rise to 7,500 as our 2026 S&P EPS estimate would go to 328 and our target PE would rise to 23x. It is important to note that earnings growth almost exclusively comes from reinvesting retained earnings and depreciation. Consequently, a lower corporate tax rate increases the after-tax return on investment and boosts the expected earnings growth, resulting in a higher multiple. A 15% US corporate tax rate would also likely spur increased foreign investment, improving growth prospects for US companies and potentially lowering US bond yields.
To justify a 23x multiple, the 10-year treasury would have to return to the 3-4% range from the current level of 4.3%. Inflation would have to be near 2% to justify a 10-year bond yield in that range. If one adjusts inflation for the distorted shelter and auto services components, reported CPI would have been zero over the last year. The key drivers of inflation are money supply growth and energy prices, both of which are down year-over-year, implying further future deceleration of inflation. Those two factors caused all the high inflation of the 70’s as energy prices increased 1,200% and money supply growth averaged 10% per year vs. an average growth rate of 5% per year since WWII.
Our Macro models indicate that Trump’s policies are disinflationary not inflationary as growth incentives increase GDP and, therefore, reduce the ratio of the Money Supply to total goods and services (Quantity Theory of money). Specifically, tariffs that fund investment spending increase GDP growth. The increase in the prices for certain goods caused by the tariffs is a one-time effect so does not produce ongoing price increases and even the one-time increase is unlikely to have a material impact on CPI as it is dominated by services and energy prices. It is also important to note that the deportation of asylum seekers, who are not permitted to work, is actually disinflationary as they are on government assistance programs that increase the deficit and reduce investment capital. In addition, deportations will occur slowly over time and are unlikely to have a material impact on the $30 trillion US economy.
The other key driver of interest rates is the $56 trillion global pension market growing at 5.5% per year. These pension funds typically have a target allocation of bonds/stocks and are likely to rebalance at both month-end and year-end, creating a deep bid for government bonds. We believe that this demand combined with gradual reductions in reported CPI numbers will cause the 10-year rate to decline in the next 3-6 months substantially below 4%.
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