Capital Economics has reaffirmed its forecast that the S&P 500 index will reach 7,000 by the end of 2025, despite recent market turbulence. In a research note published on Monday, the firm acknowledged last week’s downturn following the Federal Open Market Committee (FOMC) meeting but remained confident in its outlook.
“We are holding to our projection that the S&P 500 will close next year at 7,000,” the analysts stated. This forecast is being maintained even though the firm anticipates Federal Reserve policy to be slightly less supportive than previously expected.
The recent slide in the S&P 500, according to Capital Economics, was primarily influenced by a sharp sell-off in the government bond market. “From a market perspective, this reaction is understandable,” the firm noted. However, they expressed confidence that the yield on 10-year Treasury Inflation-Protected Securities (TIPS), often seen as a benchmark for risk-free returns in equity valuations, will not rise significantly by the end of next year.
Capital Economics highlighted that the S&P 500’s performance is not solely determined by risk-free rate components. The relationship between the index and its forward twelve-month (FTM) earnings yield has been inconsistent since late last year. This inconsistency is partly attributed to rapid growth in the S&P 500’s FTM earnings per share (EPS), which has buoyed the index despite fluctuations in the earnings yield. The firm also noted a significant decline in the forward equity risk premium (ERP).
“We anticipate modest growth in the S&P 500’s FTM EPS next year,” the firm explained, “and we expect the FTM ERP to shrink further, even though it is already at relatively low levels.”
Capital Economics concluded by emphasizing that the current ERP remains well above the lows reached before the dotcom bubble burst. They likened today’s market dynamics to a prior period of excitement around transformative technology that fueled significant stock market gains.
