S&P 500 2025 3 Roads Diverged – The Great, The Good, and The Ugly

Three roads diverged in a yellow wood…oh wait, that’s not the poem. The OAK Harvest investment team gets often asked about scenario analysis and other potential outcomes for the stock, bond and financial markets. This makes sense as no ones crystal ball is perfect each in every year. Given its year end 2024, we already alluded to our best guess for now to where markets end 2025, 6660 currently, as well as the optimistic repeat of Trump 2.0, S&P 500 equals 7000, and everyone else’s 2025 outlooks have been posted, I figured I would leave our followers with 3 scenarios for 2025 along with historical precedents that one could follow along with if you want. Let’s call them, the Great, The Good, and The Ugly!

First off, the Great scenario. We’ve discussed this one multiple times even back in the 3q of this year in front of Donald Trump winning reelection in early November. The Great for 2025 is Trump 2.0 in 2025 mirrors Trump 1.0 in 2017. Here’s the 3 overlays of the most important charts for that scenario. First the S&P500, then 10-year Treasury yields and finally the DXY dollar currency basket which I personally think will be the key to 2025.

Recall 2017 turned out to be Goldilocks on steroids for investors and a nightmare for traders. Why? Because the great drawdowns throughout 2017 amounted to barely -3.5% and after the 1st quarter the max drawdowns in the S&P 500 ranged from 2.5% to only 1.5%.

2017 was glorious to bulls because earnings surprised to the upside on the back of a decent economy, long term interest rates declined on the back of a Fed that was raising rates and an economy who was slowing as well as inflation was gradually declining. Throw into the mix the Dollar went on a 12-month selloff that boosted other global assets and markets such as China, and if you were long most everything except energy, you made money. A repeat of all of these can get the S&P500 to 7000, but my work says that requires volatility to collapse below 12 like it did in 2017 and like it was doing in the realized vol markets pre-election and in late November.

The second scenario is merely “The Good”. What’s the Good in our work? It about 6660 on the S&P 500, which would be about +12-13% from our current 5900+ on cash S&P500. The good is a continued soft landing in the economy. Higher earnings, flattish long bond yields, and a peaking to stable dollar. The “Good” scenario anticipates a range of normal volatility that we’ve experienced over the last 10-15 years leaving out the Covid collapse. That’s a range of implied volatility futures from say 14 to 22.5. I said volatility futures not spot Vix as I have found little to no study linking the level of Spot vol to equity returns. The trend? Yes. And the level relative to forward volatility that’s actually traded? Yes. But no actual spot vol that’s a calculation.

The best historical precedent for this one is probably 1994-1997 with 1995 being what we just experienced this year in 2024. We actually discussed this 1995/96 period early this year as many doomers were calling for crashes and economic calamity. Why did we reference this one? Well this is one of the few times in stock market history that the Fed Reserve was actually able to engineer just a economic slowdown without causing a dramatic economic downturn, recession or financial collapse in markets.

Back then, Greenspan and the Fed cut rates to 5.25% from 6% in the six months in the 2h95, cooling the economy without tanking it. As much hysteria as there is in current financial press about rising long term treasury yields, even back then US Treasury yields ended higher in the 12-month period following the first rate cut. Overall bond total returns trailed cash returns, meaning you wanted to stay in shorter term maturity treasuries for the soft landing. Here are the same three charts SP500, 10year Treasuries and the dollar index from 1995-96 overlay with 2024/25.

1996 still saw a soft landing for the economy, but market volatility ratchetted higher throughout the 1h96. Right now, the forward volatility markets suggest that this is a likelihood again in 2025. The bull would run on in 2025 and end the year higher, but the bulls might take a nap come late February and spend much of late 1q25 and 2q25 dealing with higher volatility under this scenario.