Welcome to RBC’s Markets in Motion podcast, recorded June 2nd, 2025. I’m Lori Calvasina, Head of US Equity Strategy at RBC Capital Markets. Please listen to the end of this podcast for important disclaimers.
The big things you need to know:
- First, we are modestly revising our YE 2025 S&P 500 price target, taking it up 3% to 5,730 from 5,550. Our valuation and earnings models drive this number.
- Second, we view sentiment as the main risk to our call. Even though it’s been melting up in recent weeks, our sentiment model (based on AAII net bulls) is the still the most constructive one in our price target toolkit, and our analysis of S&P 500 moves off the lows of the major post GFC drawdowns indicates that the index could have more room to run through year-end 2025.
- Third, we review the case for and against Small Caps, which were in focus in our meetings last week. We remain neutral as Small Caps have been derisked to a greater degree than Large Caps, making an underweight unwise, but the conditions for outperformance seem elusive.
If you’d like to hear more, here’s another six minutes. While you’re waiting, we need a favor. The Extel survey, formerly known as Institutional Investor, opens today. If you’ve found this podcast helpful, we’d appreciate your support in the Portfolio Strategy category. Last year we were honored to rank #3 in a tight race, our first time in the top three. We suspect our podcast listeners did a lot to help us get there, and we’d appreciate your support again.
Now, let’s jump into the details.
Starting with Takeaway #1: We Are Lifting Our YE 2025 S&P 500 Price Target To 5,730 From 5,550
Our new price target reflects our belief that the stock market is on a slightly better path than the one it was on April 4th, when we cut our target for the second time in 2025, but not back to where it was in January or even mid-March when we cut our target for the first time. As a reminder, we see our price target as a navigational tool, but more of a compass than a GPS which we revise when new information becomes available, similar to how most stock analysts revise their company-level forecasts continually throughout the year.
As always, the price target itself is driven by the math of our models. Following our latest round of updates, the median outcome of the five models we used is 5,730. The range of outcomes remains wide, from roughly 5,500 to 6,400, highlighting the high degree of uncertainty persists.
We see 6,400, the output of our sentiment model, as our “bull case” if our official target ends up being too conservative. For a bear case, two thoughts come to mind. The first is that we suspect a more negative outcome in the stock market could take the S&P 500 down to the recession lows of our “third tier of fear” at some point before the year is up, which we estimate to be in the 4,200-4,500 range.
Another reasonable bear case comes from our valuation model, which suggests that the S&P 500 could end the year a little above 5,000 if inflation settles out in the low 3% range, the Fed doesn’t cut, 10 year yields end the year at 5%, and S&P 500 EPS comes in flat with 2024 levels.
The 5,730 median outcome that serves as our official YE 2025 S&P 500 price target is the output of our base case valuation and EPS modeling. We project a target trailing P/E of 21.5x based on RBC house views on key macro variables and our analysis of the relationship of these variables with P/Es going back to the 1960s, along with our own 2025 S&P 500 EPS forecast of $258.
For the base case, these models bake in inflation in the upper 2%’s, 3 Fed cuts starting in September, real GDP of 1.3% for the full year, margin contraction (more significant in the back half of the year than in 2Q), and some relief on interest expense. This is a better macro backdrop than the severe stagflation scenario that we used in early April, but is not as strong as the set of assumptions we used in January. This model is telling us is that current pricing in the S&P 500 already reflects the step-up improvement in macro fundamentals that occurred two weeks ago when the US-China trade war experienced a significant de-escalation and leaves us feeling neutral on the direction of stocks through year-end.
While the average outcome of our five models would get us closer to 5,900, we are more comfortable using the median since the two models in our targeting process that are most constructive are currently in flux. One is our earnings yield gap model, which is still in a constructive range for stocks but would flip into a negative range if 10-year yields move to 5.3%.
The other, which we’re more worried about, is our sentiment model, which reflects the idea that rebounds off extreme levels of bearishness tend to be powerful. But this indicator (which is based on AAII net bullishness) has been moving up rapidly in recent weeks and is signaling less robust forward returns than what we saw in April when it was two standard deviations below the long-term average. In just a few weeks of recovery, this indicator is already back to 1 standard deviation below the long-term average. We are keeping a close eye on it to see how fast it moves up. In recent years, a move to 1 standard deviation above the long-term average has been a reliable signal that the stock market is due for a significant pullback.
We haven’t issued a 2026 price target, but have started to plot out some scenarios for 2026 using our valuation model (the same model that produced our 5,730 price target for 2025). That work points to fair value in the 6,200 - 6,800 range for the index at YE 2026.
Moving on to Takeaway #2: Rebounding Sentiment Is The Main Risk To Our Call
Though we are worried about how quickly AAII net bulls are rising, we do recognize that a continued melt up in stock prices due to rebounding sentiment is the main risk to our call. We spent some time last week studying the rebounds in the S&P 500 off the lows of the major post GFC drawdowns, those that were 10% or more. Excluding the 2020 COVID recession, when we looked 9 months out (roughly the amount of time it would take to get from the April 8th to December 31st), the rebounds averaged 26%. That suggests that by the end of the year, the current rebound could end up around 6,300. There was a fairly wide range of magnitudes, with the weakest coming in at 17% and the most powerful coming in at 35%. At the mid-May high, the 2025 rebound totaled 20%, already within range.
Wrapping up with Takeaway #3: Why We’re Neutral on Small Caps.
- In terms of performance, Small Caps have stabilized relative to Large Cap.
- Points in favor of Small Cap include evidence of greater derisking on our positioning data per CFTC’s data….
- As well as our valuation data…
- …along with stronger EPS growth forecasts in Small Cap and better EPS revisions trends in Small Caps.
- We see two problems, however. The first is that economic tailwinds seem elusive. We’re keeping a close eye on non-farm payrolls and ISM manufacturing, as a ramp up in either tends to be associated with Small Cap leadership.
- The second is that our Rates Strategist doesn’t expect the Fed to start cutting until September, and the financial community generally seems to be dialing down and pushing out Fed cut expectations. This is important because cuts tend to spark Small Cap leadership, though it doesn’t tend to be sustainable unless it is also associated with a recession and an economic recovery.
That’s all for now. Thanks for listening – and don’t forget to vote.