S&P 500 Bottom - Up Valuation and Market Outlook for Q1 2026
Summary
It’s not a Stock Market, but a Market of Stocks
Every quarter we assess the fundamental state of the market by closely analyzing the most important companies. To understand if the S&P 500 has more upside than downside, we need to define the recent rally leaders, create DCF models for each, and set price targets.
The distance from the last closing price to the 1-year Price Target will inform us of the risk-reward currently offered by the market. We shall rely on our Machine Learning models and company guidance to generate these models. The aim of this research piece is not necessarily to create accurate models individually, but as a group.
Year Ahead Outlook
The last time we have compiled this analysis (December 2024), the average valuations for S&P 500 companies were significantly stretched to the upside, hovering around a trailing P/E ratio of 24.59. Today, valuations have meaningfully decreased, but still remain historically elevated, at 22.84 times trailing earnings.
On a forward looking basis, the 12-month P/E ratio for the S&P 500 is 20.7. This P/E ratio is slightly above the 5-year average (19.8) and above the 10-year average (18.3), according to Factset data.
Compared to the enthusiasm characteristic of December 2024, today’s environment is unusually bearish all of a sudden. Deep levels of negativity have taken over investor psychology, despite the fact that the current correction is well within the context of historical market drawdowns. Various sentiment indicators, from CNN’s Fear & Greed Index, to the AAII survey point to outright depression.
The market’s main concern lies with the impact of Trump’s tariffs on earnings (EPS) and inflation. The market hates uncertainty and has currently repriced to adjust for the unknown. Some stocks have currently corrected as if the tariffs will cause an unlimited decline in earnings and economic growth — which is, of course, not the case.
However, the price pattern exhibited so far, currently matches the volatility seen during Trump’s first term. While certain media narratives suggest that tariffs will lead to an inflationary spike in the economy, inflation actually declined during Trump’s trade war with China during his first term.
We’re not saying that we’ll get a similar outcome this time as well. But the environment that we are currently trading in may certainly bear resemblance. We may see wide swings in asset prices and more elevated levels of volatility in the year ahead. In the past, the market managed to absorb all of the uncertainty and remained in a clear up-trend. This also constitutes our base case scenario going forward.
Previously, despite these spikes in volatility, the worst potential outcomes failed to materialize. In hindsight, we can now see that market drawdowns provided repeated buying opportunities for investors to pick up stocks at lower prices. That is - if they weren’t too scared to hit the SELL button on their portfolio in the first place.
This does not mean that a more protracted corrective phase is not potentially developing. And we’re also not saying that “the correction is over”. But at current prices, the market offers a much better risk-reward proposition than it did in December 2024.
Speaking of which, let’s recap the Wall Street view published just 3 months ago…
With Price Targets for the S&P 500 ranging from 6.500 to 7.000, major analyst predictions were certainly enthusiastic. As for us and our advisory clients — we were more reserved, and set a mean price target of 6.400 for year-end 2025. The main takeaway from our previous research piece was “curb your enthusiasm”, a theme which will continue this time around as well.
Investors are prone to becoming “conditioned”, just like any other sentient being. In our case, the conditioning comes from near term precedent, which shapes expectations about the future. If reality fails up to live to these expectations, sentiment may get depressed as part of the “adjustment to reality” process.
Case in point: SPY’s compound annual growth rate over the past 2 years, is almost 27%. That is a phenomenally high rate of return, more than three times the historical average (7.5%). What happens to investors expectations in this case? Many tend to extrapolate further, making the assumption that the future will be just like the past.
The only issue lies with the fact that this extrapolation takes us to unsustainable levels - in SPY’s case, that translates into a price of $752 by year end, or roughly 7.500 in S&P 500 terms. Not even the most bullish sell-side analyst can make this assertion.
By necessity, CAGR has to normalize, which translates into a “consolidation process”. On a chart, this looks like a flat, range-trading period, where prices essentially “go nowhere” for an extended period of time. This is not fun for investors, as their portfolios stop printing ATH watermarks.
From a fundamental perspective, a pause in the trend of rising prices functions as a respite for stock valuations. There are 2 primary drivers of market returns: Valuations and Earnings per Share.
Aggregating median EPS estimates for all companies in the S&P 500 for 2025, we get an expected EPS of $275. According to the published price targets above, valuations need to range from 23.6 to 25.4 P/E in order to match targets of 6.500 - 7.000. Already, these P/E multiples are stretched to the upside, so there’s not a lot of room for expansion on the Valuation side of the equation. The only remaining price appreciation driver is EPS growth.
It is entirely possible in the next period for price growth to stagnate while EPS growth catches up and multiples adjust lower. But let’s not get ahead of ourselves here and start our bottom-up fundamental process.
Defining Market Leadership
In order for us to focus on the correct companies, we need to find out what individual stocks are leading the market higher. Helping us achieve that goal is the concept of BETA (Y-axis), combined with Market-Cap (X-Axis) and Dollar Transaction Volume (filter). A stock’s beta is calculated using both correlation and covariance; the higher the number, the more that stock is moving with the market. Having a significant Market-Cap and Transaction Volume insures that the stock is also a driver for the S&P 500 due to its weighting.
We’ve set the screener to account for all relevant factors and the market leadership can be defined as follows:
Apple Inc. (AAPL) - 7.27%
Nvidia Corp (NVDA) - 5.8%
Microsoft Corp (MSFT) - 5.89%
Amazon.com Inc (AMZN) - 3.89%
Alphabet Inc. (GOOG) - 3.71%
Meta Platforms, Inc. Class A (META) - 2.84%
Tesla, Inc. (TSLA) - 1.55%
Broadcom Inc. (AVGO) - 1.79%
Eli Lilly & Co. (LLY) - 1.46%
Walmart Inc (WMT) - 0.84%
These are the top 10 companies that matter today and are responsible for the bulk of index-level price moves.
In total, these stocks account for 35.04% of the S&P 500’s weighting.Becoming familiar with their financial prospects will lead to a much better understanding of the whole market's potential for appreciation or decline.
Analyst Price Targets and Statistics
We’ll input these stocks into a table containing the latest Analyst Price Targets (no older than 1 month), calculate the potential capital appreciation (equally weighted) as well as weighted according to index constituency.
According to analyst targets, the fundamental capital appreciation potential sits at +28.19% (compared to +10.33% last quarter), assuming equal weighting. Adjusted for index weighting, the figure is somewhat higher, at +30.13% (compared to +11.69% last quarter). Should these figures be accurate, that would translate to a $740 - $750 price for SPY in the next year. Quite excessive… we need to investigate further, using our own Machine Learning models.
Models & Price Targets
Microsoft Corp. (MSFT)
Signal Sigma PT: $487 (Lowered from $508), 10% CAGR
Analyst PT: $510
Upside: ~22%
Rating: BUY
Assumptions:
9.6% Revenue Growth
69% Gross Margins
24.5% OpEx pct Sales
23 x EBITDA Multiple
Apple Inc. (AAPL)
Signal Sigma PT: $228 (Raised from $205), 6% CAGR
Analyst PT: $275
Downside: -3%
Rating: HOLD
Assumptions:
6.0% Revenue Growth
49% Gross Margins
14.5% OpEx pct Sales
24 x EBITDA Multiple
NVIDIA Corporation (NVDA)
Signal Sigma PT: $140 (Lowered from $170), 20% CAGR
Analyst PT: $177
Upside: ~25%
Rating: BUY
Assumptions:
20% Revenue Growth
70% Gross Margins
12% OpEx pct Sales
24 x EBITDA Multiple
Alphabet Inc. Class C (GOOG)
Signal Sigma PT: $240 (Raised from $203), 20% CAGR
Analyst PT: $220
Upside: ~37%
Rating: BUY
Assumptions:
10% Revenue Growth
60% Gross Margins
24% OpEx pct Sales
17.5 x EBITDA Multiple
Amazon.com Inc (AMZN)
Signal Sigma PT: $225 (Lowered from $229), 10% CAGR
Analyst PT: $275
Upside: ~12%
Rating: HOLD
Assumptions:
9.5% Revenue Growth
47% Gross Margins
39% OpEx pct Sales
3.11 x EBITDA/FWD Sales Multiple
Meta Platforms, Inc. Class A (META)
Signal Sigma PT: $910 (Raised from $725), 30% CAGR
Analyst PT: $770
Upside: ~45%
Rating: BUY
Assumptions:
10.5% Revenue Growth
82% Gross Margins
33% OpEx pct Sales
19 x EBITDA Multiple
Eli Lilly and Company (LLY)
Signal Sigma PT: $1084 (Raised from $990), 35% CAGR
Analyst PT: $1020
Upside: ~24%
Rating: BUY
Assumptions:
12.5% Revenue Growth
80% Gross Margins
41% OpEx pct Sales
40 x EBITDA Multiple
Tesla, Inc. (TSLA)
Signal Sigma PT: $219 (Lowered from $257), 6% CAGR
Analyst PT: $345
Downside: -16%
Rating: HOLD
Assumptions:
15% Revenue Growth
15.7% Gross Margins
9.5% OpEx pct Sales
45 x EBITDA Multiple
Broadcom Inc (AVGO)
Signal Sigma PT: $249 (Raised from $197), 40% CAGR
Analyst PT: $240
Upside: ~27%
Rating: BUY
Assumptions:
20% Revenue Growth
58% Gross Margins
28% OpEx pct Sales
30 x EBITDA Multiple
Walmart Inc (WMT)
Signal Sigma PT: $88 (Lowered from $101) 10% CAGR
Analyst PT: $112
Downside: ~4%
Rating: HOLD
Assumptions:
3.4% Revenue Growth
25% Gross Margins
20.5% OpEx pct Sales
18 EV/EBITDA Multiple
General Observations
Before we create the 3 fundamental scenarios for the market (optimistic, neutral and pessimistic), we’d like to cover some observations drawn from working on the models.
Lower General Valuations
After models are computed and the main variables are determined (Revenue Growth, Gross Margins, Operating Expenses), it’s our job to place a multiple on the EBITDA result. This is one of the parts that relies on our own estimations, and not on a machine’s.
Overall, we have used multiples which have been at least 10% cheaper than in December 2024. Some stocks have seen even more significant multiple compression, and we have adjusted for that in our own analysis. Overall, using lower multiples translates into lower Price Targets and a “safer” estimation.
Flat Final Estimation
Overall, our conclusion leads up to a $675 SPY Price Target for 31’st March 2026. For consistency and comparison purposes, if we adjust the target date to 31’st December 2025 and maintain the same CAGR, the Price Target works out to $646, very similar to our prior estimation of $640. This is not necessarily bad. A flat trend from one estimation to the next, echoes what we’ve previously discussed - a period of consolidation and volatility, where valuations have time to adjust to reality. However, the ultimate result of this period is still a growing stock market, and an up-trend.
S&P 500 Valuation and Summary of Models for Q1 2026 (Base Case)
It’s time to combine the risk-reward for analyzed stocks into a single number that we can use as a proxy for the whole market. This will serve as the basis of our analysis going forward.
Combined Upside: +17%
SPY Close Price: $575.84
SPY 1 Year Price Target: $675, at 19% Compound Annual Growth Rate
Note: the Price Target reflects expectations for target date March 31’st 2026; adjusting the target date to December 31’st 2025 results in a Price Target of $646
Market Scenarios
SPY Optimistic Scenario (A) - 25% Probability
The optimistic scenario is the one Ed Yardeni and several other sell-side analysts currently envision. Growth happens at an accelerated pace and momentum picks up again. The S&P 500 ends the year at the upper end of the range, at 7.000.
2025 S&P 500 Earnings per Share: $275
Valuation Multiple: 25.4x
S&P 500 Median Price Target: $7.000 (Year-End 2025)
SPY Price Target: $700
Upside: +21%
ODDS: 25%
SPY Neutral Scenario (B) - 50% Probability
In a neutral scenario, growth occurs at a more reasonable (or should we say realistic?) rate. We’re taking into account the over-estimation margin of error that analysts have historically projected. Instead of $275 EPS, we’ll use $260 error-adjusted EPS and a valuation multiple closer to the present-day (sub 25x).
2025 S&P 500 Earnings per Share: $260
Valuation Multiple: 24.8x
S&P 500 Median Price Target: 6.450 (Year-End 2025)
SPY Price Target: $645
Upside: +12%
ODDS: 50%
SPY Pessimistic Scenario (C) - 25% Probability
A pessimistic scenario implies underwhelming economic growth. And by “underwhelming” we don’t mean it in an absolute context, but in a “relative to expectations” context. A +15% EPS growth rate would be underwhelming in this case, but otherwise perfectly aligned with historical data. Given that FY 2024 EPS was around $210, 15% growth would take this value to around $240.
2025 S&P 500 Earnings per Share: $240
Valuation Multiple: 23.3x (still elevated)
S&P 500 Median Price Target: $5.600
SPY Price Target: $560
Downside: -2.75%
ODDS: 25%
Conclusions
Of course, none of our scenarios cover a real recession so far, since even the most pessimistic assumption still takes into account 15% EPS growth. On that note, let’s examine whether more S&P 500 companies than normal commented on the possibility of a recession during their earnings conference calls for the fourth quarter.
It turns out that the answer is NO. FactSet searched for the term “recession” in the conference call transcripts of all the S&P 500 companies that conducted earnings conference calls from December 15 through March 6 and found out only 13 cited the term “recession” during their earnings calls for the fourth quarter. This number is well below the 5-year average of 80 and the 10-year average of 60.
A classic indicator for gauging recessionary fears is the differential (spread) between an OAS index of all bonds in a given rating category and the spot Treasury curve (ICE BofA Option-Adjusted Spreads). Looking at the High-Yield to Treasury spread, we can surmise that the credit market does not see difficulties ahead, at least when compared to 2016, 2020 and the 2022-2023 period, when elevated levels were recorded.
For now, the current equity market drawdown, even if incomplete, looks to be more of a buying opportunity than a selling one. Investors would do well to remember that volatility is the price they pay in order to achieve returns. This is simply what volatility looks and feels like (not good).
There is a single caveat to this. Namely that our sentiment indicator has not yet fully bottomed. Hence, even though the current phase has all of the hallmarks of a buyable dip - it may keep on dipping until really reaching painful levels.
While headlines and sentiment are getting very bearish, the bull market remains technically intact. Will this change at some point? — That is for certain!
However, only time will tell. For now, we are not seeing anything amounting to a real trend change. As a result, our equity exposure will remain elevated for a while longer, as we navigate around position and factor risk. In any case, using media headlines to make portfolio decisions has repeatedly turned out poorly. Avoiding mistakes is also an important consideration.
Feel free to reach out if you need any help with your portfolio or investing strategy! And thank you again for supporting Signal Sigma as we continue our migration to the much more powerful V2 platform!
Andrei Sota