It is easy to draw on one’s emotional bias and therefore build a believable case for what the market will do next. We think this is a mistake for investors positioning for the remainder of 2025. Instead, we will continue to let the markets tell us what is to come.

This game plan was first posted in our April 29th report titled, "The FED Can’t Save This One: Why Bonds May Break The Stock Market in 2025.” During this report, the S&P 500 was trading around 5200 and we stated that... 

“The next move will be a corrective rally that makes a lower high. The targets for this bounce are between 5600 – 6050.”

We further stated that once we see our first larger correction from this region, how the market corrects from there will likely determine the remainder of the year. 

Having an unbiased game plan still applies and continues to act as a balance beam in an emotionally charged market. We are seeing mounting evidence that this bounce may be the start of a new push to all-time highs, such as improved breadth, better than expected earnings plus the size of this bounce. However, one can’t ignore the unprecedented levels of uncertainty shown in key indexes, coupled with a growing problem in the U.S. bond market.

In this report, we’ll lay out the unbiased case for each scenario for our 2025 stock market outlook. We do this so that we can be aligned with the developing trend once it is revealed.

Why the S&P 500 Could Reach New All-Time Highs This Year

Fibonacci Retracements

There are several factors that suggest the current rally is not a bear market bounce. One of the most interesting facts is that we’ve never seen a bear market bounce retrace this much (and this quickly) without turning into a new uptrend.

The simplest method for measuring a bounce is to use Fibonacci Retracement levels. For those not familiar with this simple technique, when a market starts to bounce after a period of volatility, you simply divide the drop into key Fibonacci numbers.  So, 38.2%, 50%, 61.8%, and 76.4% retracements of the drop are areas of interest.

Using this technique, we can get an idea of the size of the current bounce relative to what history says about bear market bounces. Going back to 1929 there have been 19 bear markets, as defined by a decline of 20% or more in the markets. Once a market dropped into bear market territory, we would usually see a bounce back to the 50% retracement level before starting to trend lower.

For example, the 2000 peak entered an official bear market by declining 20% in February of 2001. In late March, the market staged a 22% rally that just barely made it over the 50% retracement of the entire drop. It then turned lower and resumed the downtrend.

March 2001 saw a bear market rally of 22% that briefly surpassed the 50% retracement level before turning lower.  Source: I/O Fund

The above scenario has been the most likely outcome for prior bear market bounces. However, of the 19 bear markets since 1929, there have only been four bear market bounces that made it to the 61.8% retracement – 1938, 1947, 2008, and the most recent bear market in 2022, which is shown below.

August 2022’s bear market rally was one of the rare bear market bounces that touched the 61.8% retracement level and turned lower. Source: I/O Fund

There is no instance, so far, where a bear market rally moved beyond the 61.8% retracement of the entire drop and was not the start of a new uptrend. The current bounce not only exceeded the 61.8% retracement level, but it also went above the 76.4% retracement level.

The rally so far in April and May 2025 has surpassed the 61.8% and 76.4% retracement levels. If it is a bear market rally, it will be the 1st ever to bounce this high. Source: I/O Fund

This shifts the probability that we are in a bear market bounce to being low, based on historic standards. It would not only be the first bear market bounce that exceeded the 61.8% retracement level, but it would be the first bear market to exceed the 76.4% retracement level.

Advance/Decline Line

The Advance-Decline Line (A/D Line) is a widely used indicator that tracks market breadth by showing how many stocks are rising versus falling on a given trading day. How it works is that each trading day, analysts tally the number of stocks that closed higher than the previous day (advancing) and subtract the number of stocks that closed lower (decline). This value is then added to the prior day’s cumulative A/D Line, creating a running total that reveals whether participation in the market is expanding or narrowing over time.

What is particularly interesting about the A/D line is how it tends to lead price coming out of periods of volatility.  The chart below shows this phenomenon leading equities to new highs in 2016, 2018, and 2022.

Note how both the S&P 500 and the A/D line topped around the same periods in all four tops. However, the A/D Line has a history of breaking out to new highs months before the S&P 500 - in the case of the 2023 recovery, the Advance Decline line broke to new highs almost a year before the S&P 500.

The Advance Decline Line tends to lead the S&P 500 coming out of periods of volatility. It has been a reliable signal that new highs will follow. Source: I/O Fund

The reason this is important is because every instance the market has had a meaningful correction since the 2008 top, the Advance Decline line would breakout to new highs months before price, signaling that a new high is the broad market is likely to follow.

Today, we are seeing the same phenomenon. The A/D line broke to new highs on April 29th, while the S&P 500 remains below its February 19th high.

The Advance Decline line topped alongside the S&P 500 in February of 2025 but has since broke out to new highs. Will the S&P 500 follow? Source: I/O Fund

If history is a guide, seeing breadth, as measured by the Advance Decline line, break to new highs, suggests price will follow.

Earnings Growth Much Better than Expected in Q1

We usually do not see large and prolonged declines while earnings are growing. We tend to see a consistent pattern of misses in earnings that is accompanied with a clear deceleration. Based on current reports, earnings are coming in better than expected, with earnings growth for the S&P 500 rising as more companies report. The index is also on track to report its second consecutive quarter of double-digit earnings growth and seventh consecutive quarter of growth.

Data from LSEG I/B/E/S as of May 16 placed the S&P 500’s Q1 2025 blended EPS growth rate at 14.3% YoY with 92% of companies reporting. Earnings growth is up more than 4 points since April 25’s 10.1% blended growth rate and up more than 6 points since April 1’s 8.0% blended growth rate.

Q1’s blended earnings growth for the S&P 500 is expected to be 14.3%, up more than 6 points since April 1. Source: I/O Fund, data from LSEG I/B/E/S

Blended earnings growth estimates for the remainder of 2025 have come down rather sharply as the market digested April’s tariff announcement, with growth now expected to be in the mid-single digit range down from the strong double-digit range.

2026 earnings growth is estimated to be rather robust, accelerating to nearly 16% YoY by Q2 before moderating to the 14% range by Q4, per LSEG I/B/E/S data. Though we are not seeing a pattern of earnings misses this quarter, these growth rates could change quickly, as Q1 26’s growth estimate has already come down nearly 8 points in six weeks. There has also been a considerable number of discussions around tariff pull forwards, to where indecisive buyers rush to make purchases before tariffs take effect.

Risks That Cannot Be Ignored: The 30-Year Stock-Bond Correlation is Breaking Amid Record Market Uncertainty

Even though we are seeing some signals that historically precede higher stock prices, one can’t underestimate the backdrop of the unique risks associated with the current stock market. For one, markets do not like uncertainty. When uncertainty is introduced into equity valuations, we tend to see aggressive repricing of perceived risk within the markets. In other words, sell first and ask questions later. This is what happened during COVID, as well as Liberation Day.

Though fear has subsided due to the size of this bounce in the markets, it’s worth noting that we are seeing a record high in the indexes that measure geo-political and economic uncertainty. The Economic Policy Uncertainty Index (EPU), which provides a quantifiable measurement of global uncertainty based on news headlines, global conflicts, tariffs, and changing tax codes, is signaling the highest level of uncertainty seen in more than two decades.

The Economic Policy Uncertainty Index (EPU) is showing the highest level of uncertainty in over a century. Source: Economic Policy Uncertainty

This is further backed up by the Bloomberg Trade Policy Index, which is also at record levels of uncertainty.

Trade policy uncertainty shot up to a record high in 2025. Source: Bloomberg Economics

To make matters more unsettling, when the markets enter a period of uncertainty, which increases market volatility, we tend to see a flight into long-duration government bonds – the tried-and-true haven. For over 30 years, when stocks go down, bonds go up, and this has been the pattern investors can count on, making a diversified portfolio of stocks and bonds the ideal instrument for weathering periods of volatility with ease.

Considering that we are seeing historic levels of uncertainty, coupled with heightened volatility, this correlation states that we should have seen a notable increase in government bonds, as investors turn toward safety. However, since the market peaked on February 19th, the ETF that tracks long dated government bonds, TLT, is down nearly 7%.

Some might suggest that the market is forward looking, and that bonds did not go higher because the market may be pricing in a full recovery. Once again, no one knows for sure, but if this is the case, then the same logic should also apply to prior periods of quick volatility - like 2010, 2011, 2015, and 2020. These were periods of uncertainty and heightened volatility that were short lived, yet while uncertainty was high during these periods, we saw investors flee into bonds, quickly pushing TLT up 25% to 53%, as shown in the chart below.

Bonds historically have moved inversely to the stock market during periods of uncertainty, though 2022 and 2025’s market saw bonds falling while stocks fall. Source: I/O Fund

Now, compare this to today’s market. We saw the S&P 500 drop into bear market territory in just over one month, with some of the highest recorded geo-political uncertainty on record. Fear and uncertainty were so elevated during this time that we saw the volatility index (VIX) post a closing price of 45.  Since 1990, there have been only three periods where we saw the VIX close over this level - 2008, 2009, and 2020.

This suggests that we are potentially seeing a 30-year correlation between stocks and bonds shift in real-time. And, if this correlation-break persists, it will pose a much bigger risk to financial markets than tariffs or political uncertainty.

Dollar Weakness and Debt Maturity Crisis Could Force U.S. Rates Even Higher

Bonds appear to be setting up for a breakdown, not a breakout. In other words, investors should expect rates to go higher while the U.S. has to refinance $7 trillion (due now) of its $9.2 trillion in maturing debt this year, with another $5 trillion due next year. The $9.2 trillion alone from 2025 is around one-third of the market value of marketable Treasury debt, and nearly 30% of US GDP.

While higher rates loom over the economy and threaten to weigh on growth, as the 10-year and 30-year rise past 4.5% and 5%, there’s also broader implications to consumers and government spending. Higher rates will put upward pressure on borrowing costs, making mortgages, car loans, or variable-rate-based loans including credit cards more expensive.

Net interest payments on debt are surging, with 2025’s estimated payments at $952 billion, up 8% YoY, and more than 175% higher since 2020. Interest payments are expected to surpass $1 trillion as soon as 2026. From 2025 to 2035, net interest payments are currently forecast to total $13.8 trillion cumulatively.

The US’ net interest payments on its $36T in debt are estimated to be $952 billion in 2025, up more than 175% in 5 years. Source: I/O Fund

The massive wall of debt that needs to be refinanced will likely be done now at much higher rates, adding even more to interest costs. For example, say that the $7 trillion in debt is refinanced at an average rate 1.5% to 2% higher, this would add an additional $105 to $140 billion annually in interest expenses simply from the higher rate structure.

Canadian mortgage lender First National says that “analysts reckon that every 30-basis point rise in the ten-year adds roughly $1.8 trillion to ten-year interest costs, sharpening the Treasury’s incentive to fund smoothly.” First National adds that 2025’s gross debt issuance will likely climb above $10 trillion based on the projected deficit and maturities, a volume that a modern market has not absorbed before.

Additionally, the U.S. dollar looks like it is heading lower, as measured by the dollar index (DXY). When this index is moving higher, money is flowing into U.S. markets, and when it is trending lower, there is a flight from U.S. markets. DXY still has, at least, one more drop in order to complete the downtrend pattern in play. This would target around $95 - $93, which is another 4% - 7% drop from current prices.

The US Dollar Index looks to have one more drop to $93-95 to complete its downtrend. Source: I/O Fund

This is a problem because the US needs foreign money flowing into its markets to finance our debt this year. For the first time since 2008, our total debt has meaningfully exceeded total domestic liquidity. 

For the first time since 2008, the US’ total debt meaningfully exceeds total liquidity.

The U.S. alone simply does not have the needed liquidity to fund its debt, meaning that we must rely on foreign liquidity flows. Yet, as shown in DXY, foreign investments are fleeing the U.S. markets at the worst possible time.

Without foreign flows, rates have to rise until bonds find buyers – yet the predicament is that the US cannot afford rates to go higher as net interest payments then compound quicker.  

A weaker dollar could also have numerous ramifications for the broader market. First, a weaker dollar could provide a tailwind to inflation as imports become more expensive, which in turn could force the Fed to keep rates higher for longer and prolong a rate cut cycle.

Second, approximately 25% of the outstanding debt, or around $9 trillion worth, is held by foreign investors – Japan with the largest holdings of more than $1.1 trillion, followed by the UK at ~$780 billion and China at $765 billion. Whereas higher rates tend to cause the dollar to strengthen by offering attractive returns for dollar-denominated investments, that’s not what we’re seeing after April’s trade policy announcements. From Morningstar:

“Conventional wisdom says new tariffs should have strengthened the dollar, since the import taxes were expected to reduce spending on goods produced overseas and shrink the trade deficit. A smaller trade deficit would mean the US would need to attract less foreign capital to keep the dollar from depreciating.”

Since the dollar is instead weakening, lower foreign appetite for debt could add more upward pressure to yields, and this fear resurfaced on Wednesday, as the weak 20-year auction pushed yields above expectations and sent equities sharply lower.

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It is easy to draw on one’s emotional bias and therefore build a believable case for what the market will do next. We think this is a mistake for investors positioning for the remainder of 2025.

Below the Advanced Tier Paywall is the Following information:

• The specific game plan for how the I/O Fund plans to navigate the remainder of 2025 including the must-watch levels
• The signals we are watching to gauge when the broad market tops and the exact levels where we will resume buying stocks.
• Dial-in instructions for a 1-hour webinar on Thursday where I/O Fund Portfolio Manager, Knox Ridley, will discuss live the I/O Fund’s game plan for 2025. If you went into this sell-off fully invested without any risk management plan, we encourage you to attend our upcoming weekly webinar for premium members held this Thursday, May 29th at 4:30 ET.

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