To The Moon

Below is an analysis and perspective on U.S. equities from Tiger Brokers' analysts.

For U.S. equities, with their high valuations, lofty expectations, and heightened uncertainties, what level of expected return could justify holding stocks?

Historically, the S&P 500 has delivered an average annual return of about 7–8%, with a standard deviation of 15–20%. This implies a 41.6% probability of annual returns falling below 4.2% of $US12M(US12M.BOND)$. Given today’s high valuations and uncertainties, 2025 is unlikely to be an “average year.” Expected returns may fall short of 8%, accompanied by greater volatility.

That said, this doesn’t mean there are no investment opportunities in U.S. equities this year. Here are two ideas:

Buy on a Potential Pullback Triggered by Policy Uncertainty.

With Trump’s inauguration, U.S. equities could experience a significant pullback due to policy uncertainty, potentially creating an attractive buying opportunity. The logic is as follows: Current high valuations, lofty expectations, and significant uncertainties mean limited upside for equities. Thus, the opportunity cost of staying on the sidelines is relatively low. Given these conditions, equity gains would require strong policy tailwinds.

However, the uncertainty surrounding Trump’s policies and his unconventional communication style could trigger a pullback. With multiple headwinds already weighing on the market, this pullback could exceed 10%. However, as long as the U.S. economy avoids a recession and inflation doesn’t reaccelerate, such a correction is unlikely to morph into a bear market.

Additionally, with market expectations for Fed rate cuts already low (1.5 cuts for the year), the Fed is unlikely to turn even more hawkish, reducing the downside risk. If a significant correction occurs, it would present a buying opportunity.

If not, staying on the sidelines remains a reasonable approach. The risk to this idea lies in the market rallying steadily without a meaningful pullback, though I consider this scenario unlikely.

Consider Delta-Neutral Strategies.

Given the uncertainty surrounding U.S. equities, a delta-neutral strategy—long large-cap stocks and short small-cap stocks—could be a viable option. Here’s the rationale:

• Scenario 1: If the U.S. economy maintains its current trajectory (strong growth and persistent inflation), the Fed’s rate-cutting pace will likely remain slow (currently projected at 1.5 cuts for the year). A robust economy would keep the term premium on interest rates elevated, with the 10-year yield staying high.

In this high-rate environment, small-cap stocks are unlikely to outperform large caps. Large-cap companies have ample cash reserves, better access to financing, and are well-positioned to benefit from the current trend of AI adoption.

In contrast, small-cap stocks face higher financing costs, limited resources for AI investments, and challenges in attracting talent, further diminishing their competitiveness. For reference, in 2024, $SPDR S&P 500 ETF Trust(SPY)$ returned +24.68%, while $iShares Russell 2000 ETF(IWM)$ returned +10.75%. Typically, small caps outperform during strong economic periods, but in 2024 (real GDP growth of +2.7%), they failed to do so. With 2025’s real GDP growth expected to slow to +2.1%, small caps are even less likely to outperform.

Source: TradingView

Additionally, as shown in the chart below, small-cap stocks face overly optimistic expectations for this year. The current 2025 EPS forecast for IWM is $9.08, reflecting a projected growth of 43.2% compared to 2024. This comes after EPS declines of 13.0% and 11.9% over the past two years.

Even during 2018, when tax cuts significantly boosted earnings, small-cap EPS only grew by 34%. What factors could drive a 43.2% EPS increase in 2025? With real GDP growth expected to slow, it’s unlikely that tax cuts and deregulation alone could deliver such substantial growth. In my view, the current expectations are overly optimistic and lack sufficient justification given the broader economic environment.

Source: FactSet, US Tiger Securities

• Scenario 2: If the economy experiences a hard landing this year, the Fed would likely respond with significant rate cuts. However, small-cap stocks typically underperform large caps during recessions.

This implies that regardless of economic conditions—strong growth or a hard landing—small caps are likely to underperform large caps this year. The risks to this outlook are twofold: To what extent has the current price action already reflected this expectation?

If much of the downside is already priced in, further underperformance may be limited. And, if real GDP growth accelerates while inflation moderates enough to allow the Fed to cut rates more aggressively, small caps could outperform large caps. However, given the current macroeconomic environment, this scenario seems unlikely.