S&P 500 IndexLong
Navigating US Exceptionalism, Valuations, & Volatility in 2025
How often do US equities deliver 20%+ annual returns sequentially? The S&P 500 index representing a broad selection of US listed firms generated 24.2% in 2023 and 23.3% in 2024.
Source: Visual Capitalist
So, what is in store for 2025? Analyst consensus points to a 10% upside in 2025 given strong economic fundamentals, AI-led capex and productivity gains, and robust earnings.
YEAR AFTER ELECTION IS KNOWN TO BE BULLISH FOR US EQUITIES
Adding to that, historically, the S&P 500 has been bullish during the first year of new US Presidency in a four-year cycle.
Since the results of the US election on November 6 2024, more than USD 15 billion has flown into the US equities over the last two months. Historical trends in the S&P 500 from election day to year-end show a positive 4% median return.
The average return for Year 1 of the election cycle is 6.7%, which is higher than Year 2's 3.3% but lower than the third year at 13.5%.
Source: Plante Moran Wealth Management
These trends are in line with the assumption that newly elected Presidents attempt to keep up electoral promises and direct resources toward significant legislative efforts during their first two years in office, before shifting focus to more market-friendly policies in Year 3.
WILL AI SAVE THE DAY OR CRUSH IT?
AI’s anticipated transformative impact is the cornerstone of US equity resilience.
The Magnificent Seven have been at the forefront of this revolution, benefiting from outsized capex and advancements that aim to redefine productivity.
Corporate earnings are projected to grow annually by 7%–14% in 2025, adding further strength.
Structural shifts in capital allocation toward AI-driven industries are expected to sustain sectoral leadership, driving equity markets higher.
Economic fundamentals remain robust, with GDP growth expected at 2.3% (above the long-term average).
The S&P 500 P/E Ratio Forward Estimate is at 23.55x, down from 24.60x last quarter & 28.16x a year ago. While expectations have eased and are testing levels of Q2 2023, concerns are aplenty on existing valuations being priced to perfection.
Source: YCharts
Historically, elevated valuations have been accompanied by speculative mania, such as the dot-com bubble when tech stocks traded at multiples exceeding 100x earnings. By contrast, today’s forward P/E ratio of 23.5x is high relative to the post-war average of 16 but remains far below the extremes of past bubbles.
Take Nvidia for example. It trades at a forward multiple in the low 30s, but is also supported by its dominance in AI, projected double-digit earnings growth, and mind blowing RoE. For the quarter ending October 2024, NVIDIA’s return on equity was >116%. Viewed in this lens, the pricing contrasts sharply with the speculative fervour of the 1990s when companies with no profits were valued based on “eyeballs”.
Moreover, concentrated market leadership is not new but has become more pronounced. The market capitalisation of the seven largest components of the S&P 500 at about $17.8 trillion represents almost 35% of the index’s total capitalisation. This is double their share from five years ago and higher than the 22% seen during the bubble in 2000.
Today’s high valuations and concentrated dominance are backed by structural profitability and scale advantages, such as Meta's USD 44 billion in annual free cash flow in 2023 and Apple's nearly USD 400 billion in revenue in recent years.
TEMPER BULLISH SENTIMENTS WITH PRUDENCE
Bullishness aside, the S&P 500 is projected to deliver modest returns of approximately 3% per annum over the next ten years, as per Goldman Sachs. Morgan Stanley shares a similar sentiment for the long-term, but also states a 9% upside outlook for 2025.
Prudence remains paramount. Expected structural shifts in fiscal and monetary policies, elevated valuations, and geopolitical risks, all temper long-term return expectations while creating a precarious yet opportunity-packed macro backdrop.
Justifications for high valuations notwithstanding, concerns persist about the limited scope for significant market upsides, and the increased risk of corrections if earnings disappoint or macroeconomic conditions turn shaky.
Geopolitical tensions, including the US-China trade disputes among other regional conflicts, could spring major shocks as well. Nearly two-thirds of about 900 executives surveyed by McKinsey & Co. assess geopolitical instability as top risk to global growth.
In a nutshell, expect to navigate this year with a delicate balance between opportunities and underlying risks lurking in the dark.
VOLATILITY CONTINUES TO BE SANGUINE
Volatility for the S&P 500 remains sanguine. The current VIX at 16.77% indicates low volatility, despite potential headwinds. Is this the calm before the storm?
A subdued VIX might be under-pricing potential risks ahead. A volatile geopolitical landscape, thanks to a President-elect who is known to be “predictably unpredictable,” could lead to episodic volatility spikes.
HYPOTHETICAL TRADE SET-UP
Prudent portfolio manager can exploit low volatility by deploying tactical risk management strategies such as reverse iron butterflies.
CME Group offers options on Micro E-Mini S&P 500 Futures which enables granular and affordable portfolio hedging strategies. Using these feature-rich products, portfolio managers can construct prudent risk management positions to limit downside risk while also gaining from upside price moves.
A reverse iron butterfly consists of four legs. Two legs, representing a long call and a long put option at-the-money, combined with an out-of-the-money short call and an out-of-the-money short put. The premiums collected from the two short legs offset the premiums to be paid for the two long option positions.
Using CME QuikStrike, a portfolio manager can easily construct a reverse iron butterfly options spread expiring on 18th July 2025.
A net premium of 311.602 index points is required for the reverse iron butterfly spread. It comprises of (a) long 6050 call (255.533 debit), (b) long 6050 put (247.712 debit), (c) short 5600 put (130.478 credit), and (d) short 6500 call (61.165 credit) as of 9th Jan 2024.
Each index point represents USD 5 translating into the net premium of 311.602 index points into USD 1,558.01 in total cost per lot. The pay-off of this spread at expiry is illustrated in the table and the chart below.
The spread breaks-even when the underlying CME Micro S&P 500 Futures contract falls below 5738 points (5.2% fall) or rises above 6362 points (5.2% rise). The maximum upside of this trade at expiry is USD 691 if the futures contract settles (a) at or above 6550 or, (b) at or below 5550.
MARKET DATA
CME Real-time Market Data helps identify trading set-ups and express market views better. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs tradingview.com/cme.
DISCLAIMER
This case study is for educational purposes only and does not constitute investment recommendations or advice. Nor are they used to promote any specific products, or services.
Trading or investment ideas cited here are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management or trading under the market scenarios being discussed. Please read the FULL DISCLAIMER the link to which is provided in our profile description.
Source: Visual Capitalist
So, what is in store for 2025? Analyst consensus points to a 10% upside in 2025 given strong economic fundamentals, AI-led capex and productivity gains, and robust earnings.
YEAR AFTER ELECTION IS KNOWN TO BE BULLISH FOR US EQUITIES
Adding to that, historically, the S&P 500 has been bullish during the first year of new US Presidency in a four-year cycle.
Since the results of the US election on November 6 2024, more than USD 15 billion has flown into the US equities over the last two months. Historical trends in the S&P 500 from election day to year-end show a positive 4% median return.
The average return for Year 1 of the election cycle is 6.7%, which is higher than Year 2's 3.3% but lower than the third year at 13.5%.
Source: Plante Moran Wealth Management
These trends are in line with the assumption that newly elected Presidents attempt to keep up electoral promises and direct resources toward significant legislative efforts during their first two years in office, before shifting focus to more market-friendly policies in Year 3.
WILL AI SAVE THE DAY OR CRUSH IT?
AI’s anticipated transformative impact is the cornerstone of US equity resilience.
The Magnificent Seven have been at the forefront of this revolution, benefiting from outsized capex and advancements that aim to redefine productivity.
Corporate earnings are projected to grow annually by 7%–14% in 2025, adding further strength.
Structural shifts in capital allocation toward AI-driven industries are expected to sustain sectoral leadership, driving equity markets higher.
Economic fundamentals remain robust, with GDP growth expected at 2.3% (above the long-term average).
The S&P 500 P/E Ratio Forward Estimate is at 23.55x, down from 24.60x last quarter & 28.16x a year ago. While expectations have eased and are testing levels of Q2 2023, concerns are aplenty on existing valuations being priced to perfection.
Source: YCharts
Historically, elevated valuations have been accompanied by speculative mania, such as the dot-com bubble when tech stocks traded at multiples exceeding 100x earnings. By contrast, today’s forward P/E ratio of 23.5x is high relative to the post-war average of 16 but remains far below the extremes of past bubbles.
Take Nvidia for example. It trades at a forward multiple in the low 30s, but is also supported by its dominance in AI, projected double-digit earnings growth, and mind blowing RoE. For the quarter ending October 2024, NVIDIA’s return on equity was >116%. Viewed in this lens, the pricing contrasts sharply with the speculative fervour of the 1990s when companies with no profits were valued based on “eyeballs”.
Moreover, concentrated market leadership is not new but has become more pronounced. The market capitalisation of the seven largest components of the S&P 500 at about $17.8 trillion represents almost 35% of the index’s total capitalisation. This is double their share from five years ago and higher than the 22% seen during the bubble in 2000.
Today’s high valuations and concentrated dominance are backed by structural profitability and scale advantages, such as Meta's USD 44 billion in annual free cash flow in 2023 and Apple's nearly USD 400 billion in revenue in recent years.
TEMPER BULLISH SENTIMENTS WITH PRUDENCE
Bullishness aside, the S&P 500 is projected to deliver modest returns of approximately 3% per annum over the next ten years, as per Goldman Sachs. Morgan Stanley shares a similar sentiment for the long-term, but also states a 9% upside outlook for 2025.
Prudence remains paramount. Expected structural shifts in fiscal and monetary policies, elevated valuations, and geopolitical risks, all temper long-term return expectations while creating a precarious yet opportunity-packed macro backdrop.
Justifications for high valuations notwithstanding, concerns persist about the limited scope for significant market upsides, and the increased risk of corrections if earnings disappoint or macroeconomic conditions turn shaky.
Geopolitical tensions, including the US-China trade disputes among other regional conflicts, could spring major shocks as well. Nearly two-thirds of about 900 executives surveyed by McKinsey & Co. assess geopolitical instability as top risk to global growth.
In a nutshell, expect to navigate this year with a delicate balance between opportunities and underlying risks lurking in the dark.
VOLATILITY CONTINUES TO BE SANGUINE
Volatility for the S&P 500 remains sanguine. The current VIX at 16.77% indicates low volatility, despite potential headwinds. Is this the calm before the storm?
A subdued VIX might be under-pricing potential risks ahead. A volatile geopolitical landscape, thanks to a President-elect who is known to be “predictably unpredictable,” could lead to episodic volatility spikes.
HYPOTHETICAL TRADE SET-UP
Prudent portfolio manager can exploit low volatility by deploying tactical risk management strategies such as reverse iron butterflies.
CME Group offers options on Micro E-Mini S&P 500 Futures which enables granular and affordable portfolio hedging strategies. Using these feature-rich products, portfolio managers can construct prudent risk management positions to limit downside risk while also gaining from upside price moves.
A reverse iron butterfly consists of four legs. Two legs, representing a long call and a long put option at-the-money, combined with an out-of-the-money short call and an out-of-the-money short put. The premiums collected from the two short legs offset the premiums to be paid for the two long option positions.
Using CME QuikStrike, a portfolio manager can easily construct a reverse iron butterfly options spread expiring on 18th July 2025.
A net premium of 311.602 index points is required for the reverse iron butterfly spread. It comprises of (a) long 6050 call (255.533 debit), (b) long 6050 put (247.712 debit), (c) short 5600 put (130.478 credit), and (d) short 6500 call (61.165 credit) as of 9th Jan 2024.
Each index point represents USD 5 translating into the net premium of 311.602 index points into USD 1,558.01 in total cost per lot. The pay-off of this spread at expiry is illustrated in the table and the chart below.
The spread breaks-even when the underlying CME Micro S&P 500 Futures contract falls below 5738 points (5.2% fall) or rises above 6362 points (5.2% rise). The maximum upside of this trade at expiry is USD 691 if the futures contract settles (a) at or above 6550 or, (b) at or below 5550.
MARKET DATA
CME Real-time Market Data helps identify trading set-ups and express market views better. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs tradingview.com/cme.
DISCLAIMER
This case study is for educational purposes only and does not constitute investment recommendations or advice. Nor are they used to promote any specific products, or services.
Trading or investment ideas cited here are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management or trading under the market scenarios being discussed. Please read the FULL DISCLAIMER the link to which is provided in our profile description.
Full Disclaimer - linktr.ee/mintfinance
Disclaimer
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