Here's what driving Wall Street's newest and highest S&P 500 forecast

By Isabel Wang

The AI craze, bull-market momentum and potential Fed rate cuts all support Wells Fargo's upgrade to the benchmark stock index's outlook

Wells Fargo on Monday lifted its year-end target for the S&P 500 stock index to 5,535 points, from 4,625 - implying additional upside of more than 6% above Monday's trading level.

Bull-market momentum, optimism around artificial intelligence and a potential easing of the Federal Reserve's monetary policy are poised to drive more upside for U.S. equities over the rest of 2024, said equity analysts at Wells Fargo Securities.

The forecast appears to be the highest target for the large-cap benchmark index SPX among Wall Street's biggest banks and research firms tracked by MarketWatch. Oppenheimer Asset Management and Société Générale last month lifted their year-end targets for the S&P 500 to 5,500, from 5,200 and 4,750, respectively.

See: Wall Street revamps 2024 S&P 500 targets after record-setting stock-market rally

"In our view, the bull market, AI's secular growth story and index concentration have shifted investors' attention away from traditional valuation measures and toward longer-term growth and discounting metrics," said Christopher Harvey and Gary Liebowitz, equity analysts at Wells Fargo, in a Monday client note.

The analysts also hiked their 2025 earnings estimate for the S&P 500 to $270 from $250, and said they see a forward price-to-earnings multiple of 20.5 times for the index - citing improving U.S. economic growth and "superior margin expansion" from higher-margin stocks in the information-technology XX:SP500.45 and communication-services XX:SP500.50 sectors.

Megacap technology companies propelled U.S. stocks to record territory in the first quarter of 2024. The S&P 500 has advanced 9.3% so far this year, to trade at 5,202 in the early-afternoon session Monday, while the Nasdaq Composite COMP was up 8.6% and the Dow Jones Industrial Average DJIA has risen 3.4% year to date, according to FactSet data.

Not only has the secular AI story made investors willing to accept high equity multiples for the S&P 500, but so too has the central bank's monetary cycle and the beating of earning expectations for some of the momentum stocks, said Harvey and Liebowitz.

See: Fed-funds futures point to doubts over June rate cut as inflation data looms

Policy makers in March still largely expected the Fed to cut interest rates three times in 2024 - though some traders in the government-bond sector and the fed-funds futures market have begun to question whether the central bank will begin lowering borrowing costs in June, as had been expected.

Yields on U.S. government debt were rising on Monday, with the yield on the 10-year Treasury BX:TMUBMUSD10Y up 4 basis points to around 4.43%, as investors awaited Wednesday's March consumer-price index report.

Fed-funds futures on Monday pointed to a 51% probability that the Fed will lower its benchmark rate by 25 basis points in June, after earlier Monday showing a less than 50% chance, according to the CME FedWatch Tool.

See: Some good news on inflation? Fed might get it with the CPI this week.

Looking forward, Harvey and Liebowitz anticipated "a volatility spike" in the stock market in the first half of 2024, while a "melt-up" in the second half appears increasingly likely - partly driven by political developments that would support greater mergers-and-acquisitions activity, and partly fueled by a potential multi-year easing cycle that would encourage risk-taking among investors.

With this backdrop in mind, Wells Fargo analysts said they think the best way to manage the market risk and the return of a portfolio is by "barbelling" the communications sector with more defensive stocks in the healthcare XX:SP500.35 and utilities XX:SP500.55 sectors, which "allows investors to participate on the way up while providing attractive downside protection," Harvey and Liebowitz wrote on Monday.

-Isabel Wang

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04-09-24 0405ET

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