1. We are starting the new year with a YE 2025 S&P 500 price target of 6,600, a gain of more than 10% vs. November 22nd market close. Our bear case is 5,775.
6,600 – our base case – is roughly the median of five different models used based on sentiment, our valuation and earnings work, the economy, politics, and the cross-asset dynamic between stocks and bonds. The outputs of those models range from 6,200-6,700.
The story the data tells is that another year of solid economic and earnings growth, some political tailwinds, and some additional relief on inflation (which should keep the S&P 500’s P/E elevated) can keep stocks moving higher in the year ahead. We see our target as a compass, not a GPS, which we expect to revise as new information about the stock market backdrop becomes available.
There’s a decent amount of fog in the outlook as we head into 2025, and some of our models are close to levels that are typically worrisome for the direction of stocks or have been at concerning levels more recently. In our bear scenario, we estimate that the S&P 500 could end 2025 at roughly 5,775 and believe it’s a reasonable way to think about downside risks if some of investors’ worst fears become a reality.”
2. The sentiment setup is modestly constructive on a 12-month view, but has been highlighting the potential for a near-term pullback.
We remain focused on net bulls in the weekly AAII Investor Sentiment Survey where a move to +1 standard deviation above the long-term average has preceded each of the 5-10% drawdowns that have occurred in the S&P 500 since late 2022.
Last week, the four-week average was still below one standard deviation but above the long-term average, a range typically followed by an 8.6% average return in the S&P 500 over the next 12 months. That yields a potential target of nearly 6,500 which we’ve baked into our base case.
As for our bear case - back in October, net bulls crossed the one standard deviation mark several times. The 12-month forward return from that level is slightly lower (6.5%), which we’ve baked into our bear case. Importantly, when AAII net bulls are at the levels we saw in October, stocks have typically been flat over the next 3 months keeping us on guard for a pullback.
Other gauges of positioning are more concerning. CFTC’s weekly data on US equity futures positioning has been hitting new all-time highs for S&P 500 contracts.
Given what we’re seeing here, we do expect a 5-10% drawdown in the S&P 500 before too long. Timing is tricky. Seasonally, stocks tend to be strong in November-December, but more prone to weakness in January-February.
3. We don’t see a lot of room for further P/E expansion, but our valuation work still helps us see how stocks could move up in 2025.
To gauge valuation, we focus on the results of our proprietary model, which forecasts a year-end trailing P/E based on assumptions for inflation, interest rates, and the Fed, based on relationships dating back to the 1960’s.
For our 2025 price target, we’re leveraging the version of this model that bakes in RBC house views for 2% PCE, only one more cut from the Fed, and 10-year yields of around 4.6%. Those inputs anticipate a trailing P/E of 22.7x, which implies a year-end level on the S&P 500 of 6,161 on our own 2025 EPS forecast of $271 – the most conservative of our five target inputs. The P/E implied by our 6,600 target is obviously a little bit higher than what our model calls for, a little above 24x similar to where we’ve been trading on 2024 EPS recently.
For our 2025 bear case, we are incorporating one of this model’s stress tests, which bakes in inflation that reignites to 3%, no 2025 Fed cuts, and 10-year yields that rise to 5%, representing some of investors’ major fears. This exercise produces an anticipated year-end P/E of 20.8x or year-end price level of 5,631 on the S&P 500.
4. US equities may soon lose their appeal relative to bonds, but haven’t done so quite yet.
Investors have been worried about a vicious rotation from stocks to bonds within the US for quite some time which has simply not panned out. Regarding this topic, we’ve been keeping a close eye on our earnings yield gap model, which as of late November was at -0.3%, still within a range signaling gains of 12.7% in the S&P 500 over the next 12 months or a year-end price level of more than 6,700. We included that projection to our base case price target calculation.
But our earnings yield gap model is starting to run out of wiggle room. If 10-year yields rise to 5% or more, the earnings yield gap will be back in a range where the S&P 500 has typically fallen 3.2% over the next 12 months (which would take the S&P 500 to a bit below 5,800 from current levels). We’ve added that scenario to our bear case calculations.
5. The US economy is at an important crossroads from a stock market perspective.
What assumptions we should use about the US economy for 2025 is debatable, contributing to the fog in the outlook that we see. Currently, consensus anticipates real US GDP will come in at 2.0% in 2025, a number that has been moving up. Meanwhile, RBC’s economics team has been looking for 1.9% and the latest Fed SEP called for 2%.
Given the modest improvement in consensus US economic forecasts that has been seen recently, the likelihood that the passage of the election and easier regulatory backdrop can provide some tailwinds, and the tendency of the economic consensus to start out with GDP forecasts that are too low in the post-COVID era, in our base case for our 2025 price target we assume that real GDP will be able to get over the hump into the 2.1-3% range. This tends to be a healthy backdrop for stocks with an average return of 10.7%.
In our bear case, however, we’ve baked in where GDP forecasts are currently – the 1.1-2% range that has historically produced mixed stock market returns (the S&P 500 has been up 40% of the time in this backdrop) with an average annual decline of -3.4%.
6. The political backdrop presents both tailwinds and possible headwinds for stocks in the year ahead.
We see the US equity market as being in a discovery process regarding the domestic policy platform of the new administration – something else contributing to the fog in the outlook. Deregulation and improved business activity in the wake of a clear outcome are obvious tailwinds. But otherwise, right now we simply do not know what the new administration will do in regard to its campaign promises on taxes, tariffs, and immigration, or the extent to which they will do them. And it’s going to take some time to find.
In our base case for our 2025 price target, we’ve baked in the average annual S&P 500 return in years that Republicans have controlled the White House and both chambers of Congress, which is 10.9% – one of the best backdrops for stocks in terms of the balance of power. This implies a year-end 2025 price level in the index of nearly 6,600. We think including this stat in our target does a good job of capturing the impact of the better vibes that may emerge post election.
In our bear case, we bake in the 2018 annual return of the stock market (-6.2%), the only down year of Trump’s first term – which was actually one of the strongest Presidencies on record for the stock market. But 2018 was a year in which US equity futures positioning on CFTC’s data became extremely elevated in January, similar to today, after the S&P 500 rose nearly 20% the prior year in anticipation of the passage of Trump’s tax cuts. A few things hit the stock market in 2018 including the low vol unwind in the 1st quarter, the realization in the Fall that the China trade war would actually be bad for the US economy and US companies, and concerns about the Fed’s hiking cycle and QT program which came to a head in December. It’s not a perfect analogy, but reminds us about some important things as we contemplate the risks that may lie ahead.
