Navigating Uncertainty: A Comprehensive Outlook for the $SPX in 2025

Introduction

The $SPX has experienced a remarkable two-year period from 2023 to 2024, appreciating by an impressive 52.64%. This is the best performance since the two-year period of 1997 and 1998. This sets the stage for an intriguing forecast for 2025. Can the market sustain this momentum and performance? History suggests that a third year of such outperformance would be abnormal, an outlier, and a reversion to the mean seems more probable.

Nevertheless, investment forecasts for the $SPX in 2025 vary widely, with Oppenheimer being the most bullish at 7,100 and BCA Research, the most bearish, at 4,450. This represents a massive range of 2,650 points, indicating significant uncertainty among forecasters for 2025. Given the index value at the end of December 2024 (5,881), this represents a premium of 20.73% and a discount of 24.33%, respectively. The median return is 12.2%, putting the $SPX at 6,600 by the end of 2025, which would still be a respectable double-digit return for the index.

Key Drivers to Note

In December, the $SPX reached its all-time high of 6,099.97 on Friday, 6 December. The key drivers pushing the index higher were strong earnings, robust economic growth, and the likelihood that the Federal Reserve would follow a path of rate cuts into 2025.

The stock market is trading at about 22 times earnings, with 10-year treasury yields around 4.80%. With yields above 4.50%, one could argue that the market may struggle to make headway. While this is not a fait accompli, we have seen the market stall as rates have risen in recent weeks. This suggests that 2025 may be a challenging year, especially for multiple expansion. Earnings are expected to increase by around 15%, according to FactSet. Markets also have to contend with the new administration, which introduces uncertainty and, by definition, suggests probable volatility.

Wednesday marks the start of the Q4 earnings season as the large banks begin reporting. Given market pricing, all eyes will be on the momentum of earnings and respective forward guidance. The key is to see expectations being met. Any sign of weakness will feed into market volatility, especially given the P/E trade-off. At 22 times earnings and an $SPX of around 6,000, aggregate earnings need to be at the $272 mark. Even the median forecast of 6,600 requires aggregate earnings per share of $300 over the course of 2025 if the multiple is maintained. Multiple expansion may offer some leniency here, but the bar is set high for the bulls. As such, earnings are necessarily a key focal point.

This has been made all the more important due to the Federal Reserve's messaging on 18 December, which cautioned about future interest rate cuts. While the Federal Reserve reduced interest rates by 25 basis points, they suggested that they would only cut rates two more times in 2025, according to the "dot plot" matrix that shows each member's future rate predictions. This plan for two cuts is a reduction from the committee’s previous intentions outlined in September.

This invariably adds to the theme of volatility for 2025 because of the nature of the time value of money. Lower interest rates tend to ease the burden of the denominator term in the time value of money calculation. That it will not align as initially expected adds a burden to the present value of the stock market. Moreover, it places much more importance and focus on the numerator, which is, of course, the driver mentioned above: earnings. If earnings do not perform, then not only will there be a burden on the denominator, but pressure will also be exerted on the numerator of the time value of money, and the stock market’s present value will be weighed down, with volatility being accentuated.

Moreover, since 18 December, hot data suggests that the Federal Reserve may actually prefer to pause with rate cuts. Friday saw a hot jobs number of 256K versus the anticipated 164K, with the unemployment rate coming in at 4.1% versus the expected 4.2%. In response, Fed fund futures are now pricing in only one cut for 2025, adding further headwinds for stocks.

Given these factors, it is understood that if economic growth as a driver softens as well, 2025 will indeed be a tough year.

Monitoring the Forecasts

We can use a variation of Bollinger band theory to track the $SPX in terms of levels and gauge which forecast has the greater probability of playing out:

Source: www.tradingview.com

Instead of using only one Bollinger band, we overlay the price chart with two Bollinger bands – a variation in their standard deviations – and “turn off” their respective simple moving averages. This effectively separates the price chart into zones:

• Zone 1 is the bullish zone.
• Zone 2 is the neutral zone.
• Zone 3 is the bearish zone.

In other words, if the price tracks in Zone 1, we would expect to see higher prices ahead, whilst a prolonged period of time in Zone 3 will likely result in a lower index value over time. An oscillation in Zone 2 will tend to move the $SPX in a sideways fashion.

Consider the monthly chart below, where we have drawn on the bullish target of 7,100 and the bearish target of 4,450:

Source: www.tradingview.com

The monthly chart will chart 12 candles for 2025, and we can consider these in their respective zones. If Zone 1 is maintained, then the 7,100 target may be achieved. However, if the candles fall into Zone 3, 4,450 will be a considered target.

We may also consider crosses into and out of Zone 2 in our analysis. If the candlesticks fall from Zone 1 into Zone 2, that will be a bearish development. However, if they regain and move back into Zone 1, that will be a bullish development. Conversely, a drop into Zone 2 and then into Zone 3 will indicate that the stock market’s present value is very much under pressure, and we would need to consider that in line with the drivers of earnings, Federal rate cuts, and economic growth.

Conclusion

As we look towards 2025, the $SPX faces a myriad of potential outcomes, underpinned by both optimistic and cautious forecasts. The exceptional performance over the past two years sets a high bar, and historical trends suggest that maintaining this momentum will be challenging. The Federal Reserve’s cautious approach to interest rate cuts, coupled with economic data, adds to the complexity and uncertainty of the market outlook.

Earnings growth remains a critical focus, with aggregate earnings needing to meet high expectations to support current valuations. The introduction of a new administration further contributes to the market's volatility, presenting both opportunities and risks.

Using advanced analytical tools such as the dual Bollinger band approach allows investors to monitor and navigate these uncertainties with greater precision. By understanding the various zones and their implications, market participants can make more informed decisions and adapt their strategies accordingly.

In summary, while the $SPX may encounter significant headwinds in 2025, the potential for rewarding returns remains. A keen eye on earnings, economic indicators, and Federal Reserve policies will be essential in steering through the volatility and capitalising on market opportunities.

References:

• Sevens Report
• Cnbc.com
• Forexfactory.com