Near-term risk-reward less favorable after snapback

• The weight of the evidence suggests a slightly more defensive near-term posture after the recent sharp market snapback.
• Markets have gone from pricing in a decent amount of bad news at the recent lows to providing less of a buffer should we have a rockier road ahead.
• The S&P 500 (5525 as of 4/25) has now bounced back within the 5500 to 5800 resistance band we have previously highlighted.
• Our work suggests the near-term upside from here is limited to 5%, while the downside should the markets come close to retesting the lows is greater than 10% (4835 low in early April). Thus, the risk-reward appears less attractive at current levels. 

After peaking on February 19, the S&P 500 suffered an 18.9% correction based on closing prices (-21.3% based on intra-day prices).

As markets were approaching these lows, our work suggested a lot of bad news was being priced into stocks and that a little good news could go a long way in helping lift markets.

Indeed, the median decline for the S&P 500 around recessions since 1950 has been 24% and the average drawdown is 29%. Said another way, near the lows, the market “was already” effectively pricing in a 65% to 80% recession probability.

Since the lows in early April, the market has rebounded more than 10% (14.8% using intraday prices). Indeed, a little bit of good news went a long way on the back of President Trump’s announcement of a 90-day pause on a majority of tariffs (outside of China).

At the same time, corporate America, so far, appears to be holding up better than many investors feared, as indicated by a solid earnings season relative to depressed expectations.

And the early indications through earnings season is the demand for artificial intelligence (AI) remains relatively healthy. Indeed, even in the face of a slowing economy, many companies simply can’t get left behind in deploying AI.

Still, the weight of the evidence suggests, unlike at the lows, there is much less “bad news” priced into the market, while the current outlook remains highly uncertain. There is less of a buffer should markets receive some bad news.

Economy slowing

In the interim, consensus estimates for 2025 global economic growth continue to ratchet down.

• As of the end of February – the consensus for the U.S. was 2.3% and that has since moved down to 1.4%.
• We are seeing also seeing broad-based negative economic revisions, including in China, Japan, and Europe.

The good news is that we likely reached a peak level of tariffs. However, even if tariffs levels come down in a meaningful way, we still expect them to remain well above the levels seen over recent decades.

With disruptions and continued uncertainty around tariffs, we do not expect a sharp near-term economic recovery. This is occurring at a time when both fiscal and monetary support appears constrained, at least in the U.S., though we are seeing more support in Europe and China.

Fundamentals – Not pricing in much risk

The entire rebound in the S&P 500 from the recent lows has been valuation expansion. 

This makes sense insofar as the abrupt move down was a contraction in valuations. Indeed, a price-to-earnings (P/E) ratio is largely about confidence in the economic and earnings outlook and as emotions can change quickly so can the valuation level.

That said, the S&P 500 is now back to a 20x forward P/E. This rebound in valuations is occurring when forward earnings estimates have just started to fall.

Moreover, this is happening against a backdrop of a still high degree of uncertainty and deterioration in the economic and earnings outlook.

For perspective, prior to the recent selloff, the peak in the forward P/E ratio was around 22x. This is very similar to the peak P/E seen coming out of COVID in 2020 into 2021.

• In 2020, we had historic levels of monetary and fiscal stimulus and the potential of a vaccine that helped drive confidence to boost valuation levels. There was also a large upward move to earnings ahead (even if investors did not know that in real time).
• At the end of 2024, we reached the 22x valuation level again, partly on the back of investor confidence in “pro-growth” polices from the administration and rising earnings and economic estimates.

It’s hard to justify markets going back to a 22x multiple in the near-term given the current backdrop of weakening economic and earnings trends and heightened uncertainty.   

Layer on top of this, the emergence of China’s DeepSeek, a lower cost AI model unveiled earlier this year. This suggests U.S. megacap growth stocks, all else equal, should trade at a slightly lower valuation level to account for more competition.

Thus, even if we apply a 21x P/E to current “optimistic” forward earnings estimates of $278, this suggests the near-term upside is limited to about 5800 on the S&P 500.

Technicals facing resistance

From a price perspective, the 5500 to 5800 band of resistance remains in place.

The upside of the band also coincides with the fundamental resistance levels just mentioned. Indeed, the March peak and the declining 200-day moving average both sit just under 5800.

To be fair, the spike in investor pessimism and the Volatility Index (VIX), also known as the fear index, as well as strong participation from the recent lows are positives and have often coincided near important market lows. But even then, the S&P 500 is about 14% above the 4835 level seen in early April.

Keeping an open mind

Our point of view is developed based on the weight of the evidence. We continue to challenge our assumptions. As mentioned in prior notes, there is a possibility that investors look through the short-term hit to the economy and earnings.

Given the valuation of a company is based on the long-term cash flow outlook, if investors gain confidence that earnings are not impaired, the market could rebound more swiftly than our base case. And technology spending and AI could outperform—It is important to remember the economy’s composition and the S&P 500 are not the same. The S&P 500 is much more dominated by megacap technology companies.

Further, on a short-term basis, a shift in investor positioning and a move from fear to greed could overwhelm fundamentals and push the market further in either direction than expected. Moreover, a stronger-than-expected policy response could change our view as could a sharp shift lower in tariff levels. 

The weight of the evidence currently suggests a slightly more defensive near-term posture following the recent market snapback. Markets have gone from pricing in a decent amount of bad news to providing less of buffer should we have a rockier road ahead.

As always, we will continue to keep an open mind and follow the weight of the evidence and keep you informed as our views evolve.