Back Where We Started...
With the S&P 500 back to where it began the year - but a changing underlying narrative - we want to consider if the rally can continue or if some of our prior concerns will reemerge. Let's dig in...
With the S&P 500 back to where it began the year, we went back and reviewed our 2025 outlook.
In late December (here), we provided some of market thoughts for 2025.
At the time, the market expected two Fed rate cuts. Despite having priced in as many as four cuts over the past month, the current expectation is that the Fed will cut two times this year.
Interestingly, entering the year, Torsten Slok, the Chief Economist from Apollo gave a 40% chance to rate hike.
Given the tax cut proposal, this may become something to consider. That said, two weeks ago Torsten saw a 90% chance of a Voluntary Trade Reset Recession (“VTRR”) (here) which seems less likely today.
Although we expected the S&P 500 to gain ~5% (6200) in 2025, our major concerns were:
Overly optimistic earnings outlooks.
Valuation that left little room for error.
The US Fiscal Situation characterized by high debt outstanding ($37t); a near-term debt maturity wall ($9t in 2025); and fiscal deficits that previously have only occured in war time and recessions.
Our concern with the fiscal situation was that the bond market would demand higher yields for longer-dated US Treasuries - as we saw in 2022, this could put pressure on equity valuations. (See chart 4, below).
The Treasury Secretary transition from the Wizard Yellen, who used novel tricks to provide liquidity to the economy and markets, to the Novice Bessent.
Let’s try to address these one by one:
Earnings have been revised lower; however, there is a new, more optimistic consideration.
Many companies have raised prices with the expectation of high tariff levels. Although the tariff levels may be reduced, the price increases may be here to stay. That could mean higher earnings.
Furthermore, with the new tax cut proposal, earnings expectations, particularly for 2026, could move higher. (See chart 2, below).
We always view valuation as a measure of risk and valuation remains heightened (21.7x next 12 months earnings).
However, over the past month, we saw the Fed Put (the idea that if there is equity market volatility the Fed will come to the rescue with easier policy) replaced by the Trump put. While Trump never admits defeat, he is often quick to pivot.
With the initial tax cut proposal, the US will see no fiscal responsibility.
As a result of the lack of fiscal discipline, we remain concerned that the “bond vigilantes,” will at some point force the US to either pay a higher yield or adopt some fiscal tightening. Timing this will be next to impossible, but the 10-Year Yield will be our guide.
The Novice Treasury Secretary Bessent seems to have found some tricks of his own and it is clear that not only is he a voice of (relative) reason within the Trump administration, but he has a clear appreciation for market forces and recognizes some of the tools at his disposal.
In other words, with the roll-back of tariffs and the recent tax proposal, the earnings outlook may be better than what is currently priced in.
Despite our concern with the top-decile S&P 500 valuation, without a catalyst, we have seen valuation remain at elevated levels for extended periods.
The big risk in our view is the bond market. Will yields move meaningfully higher because of either Fiscal irresponsibility or inflation?
Two weeks ago (here), we noted the number of technical indicators (market-based signals and chart patterns) that we had highlighted (we have another in chart 5, below) that were foreshadowing continued upside and questioned whether the optimistic market or pessimistic economists were “right”.
It seems that once again the market has won this age old battle.
There is a market adage “price moves first, narrative follows.”
This is why we show these charts and indicators - even when they appear “wrong.”
Re-reading that Technical vs. Economist note from two weeks ago, we highlighted that “our concern for the last 10 months [is that] the bull case is dependent on the behavior of 10-Year yields and essentially the market ignoring the US debt / fiscal situation.”
“Back Where We Started”
1. S&P 500: Considering the Upside Scenario
Source: TradingView. Through year-to-date 2025.
The chart above shows the S&P 500 ETF (ticker: SPY) with its 200-day moving average (curved light blue line).
As the S&P 500 was moving higher over the past month, our view was that the real test to the upside advance would occur at the 200-day moving average.
With the announcement of the China tariff detente (“unliberation” day?), the S&P 500 jumped above its 200-day moving average (as did the Nasdaq 100) without a pause or a fight.
Last Thursday, when I showed the chart of the Nasdaq 100, I had considered drawing in a bullish inverse “head and shoulders” pattern. At the time (five days ago), it seemed I would have time to show the pattern as it would take longer to develop if at all.
Today, a bullish inverse “head and shoulders” pattern seems like it has triggered (price above the neckline) and is worthy of mentioning and including in our process.
Remember, a head and shoulders is typically characterized by a two small arcs (the shoulders) off-set by a larger arc (the head). We have noted these in green arcs on the chart above.
The arcs all peak around the same level - the “neckline”.
“Head and shoulders” are symmetrical patterns - meaning that the point difference from the “neckline” and the bottom of the “head,” is the expected point difference between the “neckline” and the upside target.
For the S&P 500 ETF, this would mean that the price target would be $646 (~10% from current levels). (563-480 = 83; 563+83=646).
Although I am not aware of any timing to achieve a “head and shoulders” target, in my experience, it is more of a 3-6 month event rather than a 1-2 year event.
This type of upside scenario is an optimistic case (not our base case), but in our view, combined with the bullish technical indicators that we’ve highlighted over the past month, worthy of consideration.
(This is not a recommendation to buy or sell any security and is not investment advice. Past performance is not indicative of future results. Please do your own research and due diligence).
2. Are S&P 500 Corporate Earnings Expectations Now Too Low?
Source: FactSet and Luminos Advisors. Through year-to-date 2025.
The chart above shows the Actual and Estimated S&P 500 annual earnings growth.
Since “Liberation Day,” we have been focused on 2026 earnings.
Our view for sometime has been that $300 in S&P 500 earnings is a good number to consider for 2026.
However, given the reversal of most of the Liberation Day tariffs and the announcement of the initial tax cut bill, $300 may be too low for 2026 earnings.
With respect to tariffs, several businesses began to raise prices with the expectation of the new tariff levels.
As tariffs come in below initial expectations, we could see these prices increases stick and for companies to increase margins to drive earnings higher.
In terms of the proposed tax bill, according to Dan Clifton of Strategas Research:
“The legislation contains 100 percent expensing of cap goods, R&D, and factories while also allowing for a more generous corporate interest deduction.
Combined, the provisions are the equivalent of a 7% reduction in the corporate tax rate.”
While a 7% reduction in the corporate tax rate is half of the 14% reduction in corporate taxes (from 35% to 21%) in the 2017 tax bill during Trump’s first term, we believe it is possible we could see a similar “pop” in corporate earnings growth.
We view corporate tax reductions as translating 1 to 1 in terms of additional earnings growth.
Currently, 2026 earnings are expected to grow 13%, with a 7% reduction in the corporate tax rate, perhaps we should consider 20% growth.
Based on today’s estimate of 2025 earnings of $265, 20% growth would mean 2026 earnings of $318 rather than $300 (the current estimate).
Applying a 20x multiple to $318 (the market seems more comfortable with 20x+ multiples than I am), would provide a year-end price target of 6360.
Notably, a multiple of 20.3x based on $318 in earnings would bring the S&P 500 to its inverse head and shoulders target of 6460 (chart 1). (The S&P 500 currently trades at 21.7x next 12 months earnings).
(Past performance is not indicative of future results. This is not a recommendation to buy or sell any security and is not investment advice. Please do your own due diligence).
3. Microsoft: A Desert Island Stock or Simply an Indicator?
Source: FactSet. Through year-to-date 2025.
The chart above shows the price of Microsoft (ticker: MSFT) shares. This is not a recommendation to buy or sell Microsoft.
About 10 years ago, in a prior publication, I wrote a piece in which I called Google “A Desert Island” stock.
If you were on a desert island for the next five years, what one stock would you want in your portfolio?
At the time, I highlighted Google.
Over the weekend, along with a friend, I was considering what today’s desert island stock would be.
Interestingly, separately, both my friend and I thought of Tesla because of driverless cars and robotics. However, neither of us own the shares and we are both uncomfortable with Tesla’s valuation.
The second name that we discussed was Microsoft.
In addition to its operating system and office cash cow; Microsoft is a leader in video games (Xbox); social networks (Linked In); corporate communications (Slack); developer tools (GitHub); cloud and AI (owns 49% of OpenAI’s for profit entity).
Please share your desert island stock ideas with me.
The reason I bring this up is not because Microsoft is or isn’t a desert island stock, but because on its Q1 conference call, Microsoft said that it had processed 100 trillion AI tokens in the quarter including 50 trillion in March.
Tokens for AI are like fuel for a car or electricity for a computer.
One of our concerns coming into the year was around AI.
Would it go through a Metaverse moment when shareholders demanded clear return on investment?; would investment in AI, a critical stimulant to the 2023/2024 economy slow?; would AI continue to gain traction or was it a passing fad?
Microsoft’s 100 Trillion token data point reflected both adoption and acceleration in AI. Companies will need to invest more and not less.
I was listening to a podcast over the weekend with Philippe Laffont from Coatue, a tech-oriented growth hedge fund that has branched into venture capital. What he said, struck me:
“I feel now there's a chance when you look at the next year or two, at some point, tariffs goes away. Trump makes this big deal with deregulation, the tax breaks sort of cancel out the tariffs. We move on and what are we left with?
We're left with tokens. And I think the world of tokens for me, I've been doing this for 35 years. It's maybe the most exciting trend and thing that I've seen.
And all these people that say, oh, this is the end of American exceptionalism. I almost wanted to say, no, you guys are wrong.
This is the beginning of American exceptionalism because we've got Wall Street and we've got Silicon Valley.”
(Philippe Laffont is French by descent but lives in the US).
(Past performance is not indicative of future results. This is not a recommendation to buy or sell any security and is not investment advice. Please do your own research and due diligence).
4. 10 Year Treasury Yields: Still the Big Risk…
Source: TradingView. Through year-to-date 2025.
The chart above shows the 10-Year US Treasury Yield.
While the proposed tax cuts are likely good for corporate profitability and for many individuals, according to Dan Clifton, they will cost the government $3.7 trillion over 10 years.
Our concern has been that with the $37 trillion in debt outstanding and elevated fiscal deficits that the bond market would require the US to pay a higher yield on its long-term debt.
This, in our view, remains the biggest risk to the equity market.
(Past performance is not indicative of further results. This is not a recommendation to buy or sell any security and is not investment advice. Please do your own due diligence).
5. Another Bullish Technical Signal
Source: SubuTrade. Through year-to-date 2025.
The chart shows the times over the past 30 years that more than 58% of the S&P 500 shares have simultaneously hit a 20-day high and the subsequent performance of the index.
Over the past 35 years, 9 and 12 months after 58% of the S&P 500 has hit a 20-day high, the index has had positive performance every time.
The average 9-month return has been 12.6% while the average 12-month return has been 16.3%.
Although the 9 and 12-month returns have been attractive, the near-term performance has been less consistent.
Chris Verrone, the Head of Technical and Macro research at Strategas, said:
“What the 20-day high confirmation allows is for one’s thinking to evolve from “any renewed weakness can be exploited,” to something more along the lines of “any renewed weakness is likely to remain contained.”
We’re frequently asked, “does the 20-day high data ever mislead or miss?” It’s markets… of course there are exceptions and bad signals, but they are generally few and far between with this indicator.”
(Past performance is not indicative of future results. This is not a recommendation to buy or sell any security and is not investment advice. Please do your own research and due diligence).