MARKET UPDATE [June 2025]

In this brief update, we share our latest estimate of market valuation, guided by our internal models, along with an update on the equity risk premium, using the implied premium derived from the S&P 500.

We begin with a model-based view, explaining how the key inputs have changed and what those changes mean for our valuation outlook.

We then turn to developments in the implied equity risk premium and consider what recent movements may suggest. We also provide our estimate of the S&P 500’s fair value under different ERP levels, especially in scenarios where the premium rises. As always, a higher premium tends to imply lower valuations, and we walk through how that could unfold.

Finally, we use a multiples-based approach to cross-check our view. Here, we measure cash flows by adding up dividends and share repurchases across the index. We focus on cases where valuation multiples move back toward their historical averages.

#1. Model Inputs update

We apply a discounted cash flow approach to valuation, using the aggregate dividends and share buybacks of S&P 500 constituents as the measure of cash flows. These figures are sourced from the quarterly updates published by S&P Global. Historical data on buybacks, dividends, and earnings can be accessed through the following link:: S&P 500® | S&P Dow Jones Indices

The latest earnings per share (EPS) estimate stands at 242.70, representing a 1.46% decline from 246.31 two quarters ago. Over the same period, combined dividends and share repurchases increased by 6.9%, rising from 176.01 per share to 188.09. The payout ratio—dividends and buybacks as a percentage of earnings—remained relatively stable at 79.91%.

At the same time, the benchmark risk-free rate, reflected by the long-term Treasury yield, has increased. This rise in yields led to an upward adjustment in the discount rate used in our model, which we estimate to be approximately 15 basis points at the time of our analysis.

Taken together, these developments led to a roughly 2% decrease in our baseline valuation of the S&P 500.

#2: IERP Update

The implied equity risk premium (IERP), our preferred gauge of perceived equity risk in the U.S. market, remains largely unchanged since our initial bear market call in January. This comes despite a sharp rise of 60 basis points in early April, coinciding with the initial developments of the so-called "Liberation Day," when the Trump administration announced broad tariff measures affecting several major trading partners.

Below is the historical data for our internally measured IERP:

Further details on the relationship between the equity risk premium (ERP) and market returns are outlined in our first market update of the year, available here:: [Emergency Update: Call for Caution for U.S Equities].

#3: Scenario Updates

Given the mean-reverting nature of the implied equity risk premium (IERP) and its currently low levels relative to historical norms, we maintain our bearish outlook on the market, anticipating an eventual rise in the IERP.

Below, we present the output of our valuation framework under varying IERP scenarios. Specifically, we illustrate the estimated S&P 500 valuation at the historical mean IERP, as well as at +1 standard deviation (σ) and +2σ above the mean. Historically, our analysis suggests that an IERP level of at least +1σ has been a necessary condition for identifying attractive long-term buying opportunities in the market.

Scenario 1: IERP reverts back to the long term average

The valuation output presented below should be familiar, as it reflects the same framework we use in our daily updates of the S&P 500 valuation—also referenced earlier in this report.

With the current index level hovering around 6,000, our model suggests that a reversion in risk appetite to historically normal levels would imply a market decline of approximately 22%. This represents a significant downside risk associated with a potential correction back to the long-term mean.

Scenario 2: IERP overshoots mean the tests +1ϭ level

Based on observations of implied equity risk premium (IERP) levels over the past two decades, the level corresponding to +1 standard deviation is approximately 6.14%. Historically, this threshold has marked exceptional long-term buying opportunities, typically occurring near the end of bear markets.

Reaching this level has consistently aligned with major market bottoms and has served as a reliable signal for shifting our market regime stance back to a “Risk On” environment.

Based on our model, the implied equity risk premium would reach the +1σ threshold of 6.14% if the S&P 500 were to decline to approximately 4,068. This implies a potential downside risk of 32% from current levels for long investors before a historically reliable "Risk On" signal would be triggered.

Scenario 3: IERP overshoots +1ϭ level to +2ϭ level

Such a scenario typically coincides with IERP levels seen at the onset of an economic recession. During these periods, price levels and valuations are often significantly compressed, creating attractive opportunities to reestablish equity exposure at compelling long-term prices. Should these conditions materialize, the following valuation outcomes can be expected.

This represents a potential downside of approximately 66% from current index levels.

#4. Multiples Valuations

In addition to our discounted cash flow valuation framework, we also employ a multiples-based valuation approach. The purpose of this is to provide an alternative perspective that can help mitigate potential estimation errors inherent in the discounted cash flow method. This complementary approach adds value by reflecting how many market participants commonly assess valuation. Valuation multiples are often favored for their simplicity and efficiency in arriving at a market value estimate.

Since our initial bear market call, the valuation multiple has contracted from nearly 35 times cash flows to approximately 30 times, which is the level we observe today. Based on current cash flow data from our latest update, the table below presents potential index levels across a range of multiples scenarios, spanning from +2σ to -2σ relative to historical norms.

#5 Putting it All Together

Bringing all factors together, our downside target for the S&P 500 falls within the 4,000 to 4,300 range, consistent with the guidance provided in our most recent market update. (CONTINUING MARKET UPDATE).