UBS Defies Skeptics with Bold Prediction: S&P 500 to Soar Amid Tech-Driven Boom

As 2024 draws to a close, concerns about high valuations in the U.S. equity market have been prevalent among many analysts. Yet, UBS offers a contrarian perspective, asserting that current stock prices are justified and suggesting further upward momentum. The S&P 500's expected price-to-earnings ratio currently stands at 22.2, significantly above its 30-year average of 16.8 and nearing the peak levels observed during the 1999 tech bubble.

While numerous Wall Street strategists have highlighted the possibility of a market pullback due to these lofty valuations, UBS, led by strategist Jonathan Golub, presents a distinct view. In their latest report, they argue that such elevated levels are rational and project an upward trajectory into the following year.

UBS identifies several factors underpinning this assessment. Firstly, the increasing dominance of technology stocks within the S&P 500 significantly contributes to the elevated valuation metrics. Around three decades ago, before the advent of the internet and smartphones, tech companies constituted a mere 10% of the index's market value; today, they account for 40%. This shift is supported by faster revenue growth and higher profit margins in tech firms compared to their counterparts.

Moreover, UBS analysts note that both tech and non-tech sectors are experiencing improved cash flows, partly due to reduced capital intensity. This enhancement bolsters shareholder returns, facilitating higher trading multiples for stocks.

Another factor supporting higher valuations is the lower discount rate environment. Although the 10-year U.S. Treasury yield is currently 40 basis points above its long-term average, credit spreads are 220 basis points below the norm. Combined, these elements have decreased the cost of capital by about 20% relative to historical averages, explaining the elevated valuations.

Lastly, UBS points out that valuations tend to rise during non-recessionary periods, indicating a possible continuation of this trend into the next year. Given that recession risks are currently subdued, P/E ratios could increase further by 2025.

UBS's insights provide reassurance amid widespread concern, with many investors remaining optimistic about the U.S. stock market's performance in the coming year. Recent developments, including the election-related optimism, have fueled expectations of regulatory and tax reforms that could sustain earnings growth.

Looking ahead, UBS suggests that the current economic prosperity marked by robust growth and market returns might extend through 2025. In the most optimistic scenario, they foresee the S&P 500 reaching 7000 points next year, highlighting a hopeful vision of a "roaring twenties" period.