One Big Beautiful World

Having just returned from a research trip to Japan, visiting companies, retail shops, and new and old acquaintances, my conclusion is that the "Trump Rally" has gone global. A new era of productivity gains, renewed economic growth, margin expansion, and yes, recently released "animal spirits" —  accompanied by benign central bank policy — is driving global markets higher. (For more on the Japanese version of the rally, see the sidebar.) After carefully reviewing the present set-up, and particularly the likelihood of further top-line growth and margin expansion among world-leading US corporates, Federated Hermes has upgraded its forward earnings outlook. We also have increased our 2026 S&P 500 price target from 7,500 to 7,800 and introduced a 2027 target of 8,600. This memo reviews how we think we will get there. 

1. Nominal GDP growth should accelerate in 2026. In previous memos, we've extensively listed the forces driving the likely economic acceleration that lies ahead, most recently in The half-full glass. These accelerators include the beneficial impact of President Trump’s deregulation campaign, the investment incentives in the One Big Beautiful Bill, the still unspent more than $700 billion infrastructure bill allocations (which must be committed by year-end 2026), the impact of Trump’s trade deals on in-bound US investment and a likely determined effort by the Treasury Department to lower mortgage rates and reignite the housing sector. Given an expected inflation rate of 2.5%, nominal GDP should run north of 5% in 2026 and 2027. As regular readers of this space know, stocks eat NOMINAL GDP, not the real GDP favored by establishment economists.
2. Labor market should remain ‘not too soft, but not too tight.’ One element of the post-Covid economy that held back growth was a severe labor shortage that is now easing, largely due to AI efficiency gains, government cost-cutting, the ongoing housing market recession, and extra-high real interest rates driven by a backward-looking Federal Reserve. With the Fed now in a (belated) cutting cycle, we expect employment to pick up. But as AI efficiency gains spread into the broader economy in 2026 and 2027, the severe labor shortages of the Biden-era seem unlikely to recur. This could produce a "Goldilocks labor market": strong enough to support consumption growth but soft enough to keep inflation — and the Fed — under control.
3. AI productivity gains should begin to accelerate. Across the world, and particularly across the US, companies of every stripe are incorporating the AI revolution into their work processes, likely unleashing a new era of productivity gains. Productivity readings within the economy have already picked up, and we anticipate the next three years to see productivity gains average 3.5% versus the more mundane 1.4% we experienced in the last three years.
4. Inbound investment to the US should be a new driver. Beyond the daily headlines of Trump’s latest trade deals, our visits with corporate management in Japan highlighted for us just how real all this is. Company after company said they are particularly focused on this issue, and not just in relation to the US but also elsewhere. "Local sourcing" was already underway in the early 2020's as China's big cost advantages faded and supply-chain lockdowns exposed vulnerabilities; Trump’s tariff resets are only accelerating the trend already in place. As the world’s largest economy, the US stands to gain the most from the global reshoring trend.
5. The Fed is in a new cutting cycle. We've written about this extensively, so we won't belabor the point. With rates at 4.25% against a core inflation rate of 2.5%, the Fed has a long way to go in this easing cycle. Although the broad economy is not as rate-sensitive as it once was, certain sectors are (housing, small companies, regional banks), and they have been in a two-year recession. Relief here will be a welcome rocket booster to overall growth.
6. Corporate margins should continue to expand due to ongoing economic mix shift, along with widening AI investments. Over the last decade, it’s been very common to hear market strategists warn of “peak profit margins.” Although margins have vacillated, when you examine the long-term trend, you will find that, in fact, corporate profit margins have steadily increased over the last 20 years by an average 4% per year. Some of this has to do with the rising mix of higher margin businesses within the market indices, and some with the ongoing ingenuity of corporate managements to shift their business mix toward ever-higher value-added products and services. And some of it reflects plain-old productivity gains driven by automation, AI investments and other improvements. When you add it all up, we think it is time to acknowledge that the base case is continued margin expansion, not “peak margins.” When you assume margins are going up, not down, it makes a big difference for the forward S&P outlook.
7. ‘Animal spirits’ are heating up. With large elements of the global economy on "hold" for the first six months of 2025, as President Trump renegotiated tariff arrangements, companies everywhere, including Japan, are finally playing catch-up. The pick-up in M&A announcements (most recently today's Fifth Third announcement), rising IPO activity and the bounce in confidence surveys all augur well for forward activity. This bounce is hard to quantify but could be substantial given how compressed the global economic “spring” was over the first half of this year.
8. Earnings are on track to reach nearly $400 by 2028. When you factor in even relatively conservative margin gains ahead, alongside rising top lines due to higher nominal GDP growth and the ever-improving profitability mix of the companies that make up the US stock market, earnings for the S&P look pretty solid. On our revised numbers, we anticipate S&P earnings could reach $320 next year, $355 for 2027, and $390 by 2028 (three years from now). These numbers are ahead of consensus, which for 2026, 2027 and 2028 is currently $302, $336 and $373, respectively.
9. The market multiple should also grind higher. These days, it's common for market “seers” to complain that the market is expensive. At Federated Hermes, we think there are two heuristics investors instinctively turn to that are causing them to be overly cautious about the market valuation. First, they focus too much on the incredible move off the April lows, which out of context does seem spectacular and even scary. Indeed, the S&P 500 is up 36% off the lows, and the Nasdaq an even-scarier 46%. But this ignores the previous 19% decline from the highs that set up this bounce. Indeed, the year-to-date return on the S&P of 15% is far less scary, bringing it just 3% above the 6,500 year-end target we set over a year ago. A second heuristic giving false signals is the company mix of the S&P, which is ever changing. Twenty years ago, technology stocks comprised just 15% of the index, with industrials and financials accounting for a whopping 31%. Today, those percentages are almost reversed. "Asset light" businesses that can generate strong cash flows against relatively small investments should legitimately command higher multiples of earnings. As we first noted in Equity market outlook for 2025 and 2026, when you adjust appropriately for the mix shift in the S&P, a fair multiple for the overall index is probably closer to 22. This is considerably higher than the long-term average of 18x when the S&P was a more industrial-oriented index.
10. Which brings us to our long-term market target. When you add all the above up, we think a reasonable two-year S&P target is close to 8,600, implying an annual gain north of 14%. This level of return is a bit lower than the 17% annual return for the S&P over the last five years of the post-pandemic recovery but higher than the long-term annual return on stocks of 12% over the last 50 years. This level of returns is pretty attractive relative to cash and bonds and explains why we remain considerably overweight stocks at Federated Hermes. And even if it takes us an extra year to reach our 2028 EPS target of $390 for the S&P, the annual returns between here and there remain attractive and we think a reasonable two-year S&P target is close to 8,600 by late 2027. We also think returns could be better still outside the S&P itself, as the economic recovery broadens out to laggards, such as small caps, regional banks and, yes, select international markets such as Japan as the Trump effect goes global.

Markets rarely move in a straight line, and too often investors get so caught up in the day-to-day action and volatile near-term outlook that they miss the bigger picture. That picture is one of a global economy that is reaccelerating and entering a new era of productivity powered by AI and a Trump-inspired movement to use productivity gains, lower taxes, deregulation and private sector leadership to drive growth. The US is at the epicenter of what is becoming a global trend. Owners of the best global companies own, in effect, a share of this expanding global pie. No surprise then that patient investors are likely to be rewarded as the economy — and the profits it inevitably produces — continues to expand. Welcome to the One Big Beautiful World.