Research.LeutholdGroup

Discussion of Donald Trump’s policy antics could fill up this section for the next 47 months (… not that we’ve already begun to count them down). But there’s the problem of timing.

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When the S&P 500 made all-time highs the week of Thanksgiving and the following week, we viewed it as “risky, but not toppy.” Today, it is every bit as risky, but now looks toppy, too. There’s enough “wrong” with the picture that if the market immediately began to fall apart, the technical crowd would be able to cry, “It was obvious!”

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In two years, relative to the S&P 500 index, the median stock’s Price/Cash Flow ratio has swung from a 15% premium to a 19% discount. That’s only a point above our 10th-percentile undervaluation threshold. Prior breaches of that level always coincided with better times for active management—we expect this time will be no different.

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Large Cap U.S. stocks remain in a bubble phase, per the valuation thresholds we identified a year ago with a pencil and ruler. Yet, rapid growth in EPS—including our estimate for S&P 500 5-Yr. Normalized EPS—has held these measures below the extremes of the Y2K Tech bubble peaks and post-COVID mania.

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Unweighted valuation measures do not show a stock market that’s broadly overvalued. Thanks to market narrowness, it’s a stark contrast to 2021—a market we view as the most broadly overvalued of all time. It’s a good setup for active managers.

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Despite the steady decline in the Fed balance sheet under the continuing QT, “Net Fed Liquidity”—which adjusts the balance for reverse repurchase agreements (RRA) and the Treasury general account (TGA)—is actually unchanged since the fall of 2022. Not coincidentally, that’s when the current bull market began.

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The Index of Leading Economic Indicators has been out of sync for 2½ years. That dates back to the initial recession warning triggered in June 2022, a signal now deemed a failure. On an annual basis, the LEI has now logged two of its worst all-time forecasting misses in back-to-back years.

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Action in Homebuilding stocks tends to defy the popular caveat, “valuation is not a timing tool.” Readings above 2.0x book value coincided with all of the group’s major relative performance peaks; it would have been a good idea to lighten exposure when these stocks traded one tick above that level late last summer. 

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We believe stock market leadership will transition from Growth to Value in 2025. The P/E premium commanded by Growth stocks relative to Value is high, although not (yet?) quite as extreme as at the Y2K Technology bubble peak.

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January’s market trajectory is more predictive of the next 11 months than any other month. Among the “Big Four” stock indexes (S&P 500, DJIA, NASDAQ Composite, and Russell 2000), January’s best performer has beaten the worst performer over the next 11 months by an average of 5.0%.

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The March-2023 VLT buy signal led to a market gain that was the strongest and the longest in post-WWII history, when measured from the initial buy to the first monthly downturn in VLT (which occurred in January).

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A year ago, we wrote “We’re not as cautious on the stock market as we should be, because it is going up.” We’d never make such a silly argument to a fifth-grader, but we somehow felt it appropriate to share that rationale with our audience of seasoned market professionals.

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The NY Fed model puts the next twelve months’ recession probability at 29, yet based on the continued steepening of the yield curve, the model’s recession odds will continue to drop in the months ahead. But beware. Recession probability dropped to just 12% the month before the commencement of the 2008-2009 Great Recession.

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The labor market continues to send mixed signals. Initial unemployment claims for the final week of 2024 sunk to an eight-month low. However, December’s average claim level was about 9% above that of a year earlier.

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One can’t blame the stock market for not hinting that 2024 was going to be a barn burner. It did. On January 2, 2024, a critical “breadth-thrust” signal was triggered and, true to historical form, SPX delivered a 20%-plus gain through the next twelve months. Notably, an impressive aspect of the breadth-thrust track record remains intact: The index has never registered a 12-month loss after any these signals.

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Commemorating the Y2K Tech bubble today is not necessarily premature, since December 1999 was the valuation peak of that bubble—and indeed of all U.S. stock market history. Buying the S&P 500 at the end of the last century might therefore be considered the worst-timed stock market entry ever.

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Key measures of S&P 500 valuation enter 2025 at levels only seen in the final gasps of either the Tech Bubble or the 2021 post-COVID market mania. Many would counter that speculative psychology is not at the same heights as in those crazed market eras. Based on at least one sentiment measure, they’re correct: It’s higher!

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The drawback of a relative valuation ratio is that it tells us nothing about the absolute valuation appeal of either asset. While it’s relatively cheap of late, the median S&P 500 stock still trades in its top historical decile on four of five metrics.

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We’ve paid attention to an increasing number of stock-market calendar patterns over the years, boosting the odds that one of them will score a major hit in any given year. In all, we’d grade the composite of these cycles as mildly bullish for stocks in 2025.

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Our favorite market forecasting guide, Benner’s Prophecies of Future Ups and Downs in Prices shows the next big inflection year will be 2026, which qualifies as a “Year of Good Times and High Prices… Time to Sell.” That classification was on the mark in two of the last three cases (1999 and 2007, but not 2016). 

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