Market Update [September 2025]

Market Overview

September closed with a complex mix of economic signals, policy shifts, and corporate developments. Labor market weakened more than expected, with nonfarm payrolls adding just 22,000 jobs in August and unemployment rising to 4.3%. Later revisions revealed the U.S had created nearly one million fewer jobs over the past year than initially reported. Worker confidence in finding new employment dropped to its lowest since 2013, and a growing trend of “job hugging” emerged as employees hesitated to switch roles amid uncertainty. These dynamics ultimately prompted the Federal Reserve to cut rates by a quarter point, framing the move as risk management against employment weakness, even as inflation pressures remained elevated.

Trade and fiscal concerns added to the uncertainty. An appeals court struck down Trump’s reciprocal tariffs, creating questions about U.S deficit financing and intensifying debates about the Fed’s independence after Trump’s attempt to dismiss a sitting governor. Canada rolled out measures to counter U.S tariffs, and China’s trade data showed slowing exports alongside a growing surplus. In Europe, fiscal strains came to the fore: France faced a potential government crisis over budget deficits, while Fitch downgraded its outlook, even as Portugal earned an upgrade for sharp debt reduction.

Markets reflected this push and pull between growth fears and policy support. U.S equities hit record highs on optimism that Fed cuts would stabilize the economy, while gold surged to all-time highs on stagflation concerns and safe-haven demand tied to political risks, including the looming threat of a U.S government shutdown. Bond markets sold off sharply early in the month but steadied as expectations for rate cuts firmed.

Corporate activities remained vibrant, underscoring resilience in deal making despite macro uncertainty. Air Lease agreed to a cash buyout by Sumitomo, TechnipFMC secured multi-hundred-million-dollar contracts, and Skyward Specialty pursued a $555 million acquisition. Shareholder resistance complicated STAAR Surgical’s sale to Alcon, while other firms like Mobix Labs and Hafnia pursued aggressive acquisitions. On the technology front, Nvidia invested $5 billion in Intel, Alibaba unveiled a new chip, and Robinhood earned a spot in the S&P 500, highlighting continued investor appetite for growth stories. By month’s end, the picture was one of divergence: central banks cautiously shifting toward support, labor markets flashing red, fiscal positions fraying in advanced economies, and corporations pressing ahead with deals and innovation. The balance of risks leaned toward slower growth and policy intervention, even as markets managed to set fresh highs.

A.    Key Changes to Fundamental Drivers of Market Growth and Risk

S&P500 Market Cap (September -->  October): 54,765 trillion --> 56,295 trillion

Analyst Consensus Earnings Forecasts (2025): 267.5 -->  267.9

Analyst Consensus Earnings Forecasts (2026): 303.3 -->  304.9

Model Earnings CAGR: 9.03%  -->  9.23%

Model Payout Ratio %: 82.15% -->  80.51%

S&P500 Aggregate Earnings (TTM) latest quarter (in $ Billions): 489.79 -->  487.33

06/30/2025 Preliminary Earnings (in $ Billions): 545.91

S&P500 Aggregate Dividends (TTM) latest quarter (in $ Billions): 164.1 --> unchanged

06/30/2025 Preliminary Dividends (in $ Billions): 165.16

S&P500 Aggregate Buybacks (TTM) latest quarter (in $ Billions): 293.45 -->  unchanged

06/30/2025 Preliminary Buybacks (in $ Billions): 234.57

B.   Implied Equity Risk Premium

The implied equity risk premium (IERP) represents the excess return investors demand for holding equities instead of risk-free government bond. As it is not directly observable, the IERP is estimated by discounting expected future cashflows, primarily aggregating dividends and share repurchases. At Baoro Research, we calculate the IERP each month at the market index level, utilizing it as an indicator of valuation conditions, investor sentiment, and consequently, potential market direction. As of September 30, 2025, our estimate for the IERP stands at 3.93%, which remains notably below both the historical average of approximately 5.36% and the recessionary threshold of 6.16%.

C.    Market Valuations

At an average equity risk premium of 5.36%, the S&P 500 index valuation is currently 4887.48, revised down from the previous estimate of 4923.26. The decrease is driven by updated projections of slower cash flow, mainly dividends, which results in a lower payout ratio within the model and leads to a downward adjustment in the valuation estimate.

Despite the non-revised aggregate repurchase amount by S&P500 firms in aggregate, risks of such large buybacks during an extended market valuation has to be restated as per our analysis that we made in the previous month-end report.

1.      Misallocation of capital

Buybacks are most value accretive when stocks are undervalued If companies repurchase heavily at inflated valuations, they destroy long term shareholder value by paying too much for their own equity instead of investing in productive growth. This is similar to buying back “high” and then later needing to reissue equity at “low”, which may result in a net loss for various firms.

2.      Vulnerability in downturns

When markets correct, those expensive buybacks leave companies with less cash and as a result more inherent financial leverage, which is especially pronounced if firms have engaged in additional borrowing to fund repurchases. This can inherently increase financial fragility, especially in firms with greater cyclical nature to their business model.

Taking these considerations into account, the following table presents S&P 500 index valuations across a range of key implied equity risk premium (IERP) levels.

S&P500 Value (IERP @ 6.16%)

An IERP of 6.16% is commonly observed during periods of economic downturns, which for value investors can indicate a suitable moment to reintroduce equity risk into portfolios. Should the current market narrative lead to challenging economic conditions, S&P500 valuations suggest prices could decrease to 4244.39, a 57.58% decline from current levels. Despite the extent of this potential overvaluation, this remains the base case model, with the intention to reintroduce equity exposure if such a scenario unfolds.

S&P500 Value (IERP @ 6.93%)

An IERP of 6.93% is typically observed during periods of substantial market decline, such as at the height of the global financial crisis. Should a similar scenario arise, the index could experience further depreciation, with the S&P 500 potentially reaching 3,765.86, which would be a decline of approximately 77.61%. While this extent of price decrease may appear improbable, it remains within the realm of possibility based on historical precedents. For instance, equity markets dropped 89% from peak to trough during the Great Depression (1929 to 1932), while during the dotcom bust and subsequent financial crisis, the Nasdaq Composite fell roughly 78% from its March 2000 high to its October 2002 low. Similarly, the S&P 500 and Dow Jones Industrial Average both declined by approximately 50 to 57% during the 2007 to 2009 financial crisis.

Multiples Lens

Due to variability in the inputs and outputs associated with the IERP model, a multiples-based valuation is also conducted. In this approach, cash flows are represented by the sum of aggregate S&P500 firms’ dividends and buybacks on a trailing twelve-month basis.

Data from our model indicates that the S&P 500 historically has an average price to cash flow ratio of 23.4. The multiples at plus or minus one standard deviation are 28.4 and 18.4, while the values at plus or minus two standard deviations are 33.4 and 13.3. Using the most recent trailing twelve months aggregation of firm dividends and buybacks, the following valuations are derived across these key multiples.

Valuation Summary

D.    Recession Probability

The New York Federal Reserve publishes recession probability estimates based on treasury spreads, particularly the difference between the 10-year bond rate and the 3-month treasury bond yields. According to these measures, the projected recession probability for July 2026 is 28.85%, which is lower than the approximately 70% estimate reported in early 2023 during a period of heightened market inflation concerns.

The probability of a recession is determined by models, which can yield varying results depending on the model used and the weighting of different inputs. According to our implied equity risk premium-based model, the assessment is notably different.

Assuming the implied equity risk premium (IERP) decreases to 3.84% (which represents two standard deviations below the historical average) in an expansionary environment, and conversely increases to 6.16% (two standard deviations above the historical average) in a recessionary scenario, one can assess the probability of a recession by comparing the intrinsic values of the S&P 500 at these respective IERP levels to the current observed index level. According to our models, the market currently assigns an implied probability of recession at 5.01%, which is notably lower than estimates derived from treasury yield spreads. If instead the consensus recession probability of 28.95% is applied alongside our estimated range for the IERP, the resulting “fair value” for the S&P 500 is calculated at 5,948.42

E.    Canary

Our Canary model analyzes 103 sector ETFs as proxies for representative market segments, comparing current market regime performance against historical returns in similar regimes. This framework enables apples-to-apples comparisons and offers potential insights into positioning, market timing, and assessing the risk-reward profile of a specific security or sector. However, it relies on historical returns and does not account for differences in the fundamental drivers shaping the current market regime.

Consumer Discretionary: Overvalued by 20.38%

Consumer Staples: Overvalued by 1.80%

Energy: Overvalued by 27.98%

Financials: Overvalued by 33.13%

Healthcare: Undervalued by 3.23%

Industrials: Overvalued by 30.17%

Basic Materials: Overvalued by 11.79%

Technology: Overvalued by 24.89%

Utilities: Overvalued by 9.89%

F.    A- Series Value Screen Results

Each month, we conduct fundamental screening and valuation across a universe of 11,505 U.S. listed companies that meet our criteria. This month, 84 companies were screened, of which 5 were identified as undervalued.

1.      Novo Nordisk A/S

2.      Merck & Co., Inc

3.      Honeywell International Inc.

4.      Wal-Mart de Mexico, S.A.B. de C.V

5.      The Hershey Company

G. Interesting Data on Government Shutdowns

Closing Remarks

Currently, the equity risk premium is historically low, which has reduced the market’s upside potential. At the same time, our perception of downside risk remains high and continues to grow. Ongoing fiscal uncertainty, especially around the management and budgeting of government bodies, poses a substantial threat to the reliability of U.S. financial markets. The possibility of a government shutdown introduces operational challenges that may delay the release of critical data needed for monetary policy decisions aimed at achieving both maximum employment and price stability. These challenges also raise concerns about the accuracy of reported data, as highlighted by the significant revisions in recent labor market statistics over the last two months.

While markets such as the U.S. dollar, Treasuries, and gold have reflected these risks, equity valuations remain elevated. This resilience in equity prices seems to be supported by expectations of future rate cuts, enthusiasm for technologies powered by artificial intelligence, and persistent returns to shareholders through large-scale share repurchases. We believe this approach presents considerable risks for the future, as it could lead to the misallocation of capital and reduce the market’s capacity to absorb shocks during a potential and overdue economic downturn.

Even though there is a logical basis for holding a bearish outlook, there is also the possibility that we are in the midst of an AI-fueled market bubble. If this is the case, the market could continue to climb, mirroring the technology bubble seen in the early 2000s. In such circumstances, it is essential to closely monitor ongoing company guidance and quarterly results, particularly when measured against the high expectations set for these firms. In the past, the technology bubble burst due to oversupply and unmet expectations. Similarly, an overinvestment in computing power today, if it fails to yield returns commensurate with expectations, could deflate the current bubble for major AI-driven companies.