Why the S&P 500 will continue to beat bonds and cash in a muddle-through second half, say these strategists

Ned Davis Research strategists Ed Clissold and Thanh Nguyen forecast the S&P 500 will continue to outperform bonds and cash through the second half of 2025, despite recent highs. Their base case, which historically favors equities, posits slow but positive economic growth, mid-single-digit S&P 500 earnings growth (5%), and 1-2 Fed rate cuts, leading them to recommend large-cap growth stocks. While acknowledging less probable scenarios like a severe slowdown or a sharp rebound, their primary outlook suggests a 'muddle-through' environment where stocks remain the preferred asset class.

Analysis

Ned Davis Research projects a "muddle-through" environment for the second half of 2025, establishing it as their base-case scenario. This outlook anticipates slow but positive economic growth, mid-single-digit S&P 500 earnings-per-share growth of approximately 5%, and contained inflation sufficient to allow for one or two Federal Reserve rate cuts. Historically, these conditions have produced an average annual return of 8.3% for the S&P 500, favoring an overweight allocation to stocks versus bonds and cash. Within equities, the strategists identify large-cap growth as the optimal profile, reasoning that earnings-growth scarcity will allow these companies to command a premium. However, the analysis is framed with caution, detailing two alternative scenarios. A severe slowdown, potentially triggered by weak sentiment data impacting hard economic figures, could prompt a double-digit market correction and a defensive shift towards bonds and large-cap value. Conversely, a less probable economic rebound, fueled by deregulation or AI investment, would likely eliminate rate cuts and favor cyclical value stocks over growth.

Key Decisions for Investors

• Consider maintaining an overweight allocation to equities, specifically large-cap growth stocks, in line with the primary 'muddle-through' scenario where scarce earnings growth commands a premium.
• Monitor leading economic indicators closely, as a deterioration in soft data bleeding into hard data like GDP would be a key signal to pivot towards a more defensive posture favoring bonds and value stocks.
• Investors should watch for policy catalysts like deregulation or signs of accelerating AI-driven productivity, as these could signal a shift to the upside economic scenario, warranting a rotation into cyclical value sectors like financials and industrials.
• The timing and magnitude of Federal Reserve rate cuts are a critical variable; confirmation of an easing cycle after the long pause would reinforce the bullish case for equities, while any delay or hawkish pivot would challenge it.