Market sentiment is still fervent, and investors are more confident in the US economy than a year ago.
After two consecutive years of strong performance, investors expect the US stock market to continue to rise in 2025. A strong economy supports corporate profits, interest rates are easing, and President-elect Trump's growth policies have also provided impetus for the stock market to rise.
Benchmark$S&P 500 Index (.SPX.US)$It has risen more than 23% so far this year, and even with some recent pullbacks, it is moving towards the goal of a second consecutive year of increase of more than 20%, thanks to the impetus from large technology stocks and excitement about the commercial potential of artificial intelligence.
Investors are more confident in the economy than they were a year ago, consumers and businesses have adapted to higher interest rates, and the Federal Reserve is now cutting interest rates, albeit less than expected. Corporate profits are also expected to grow strongly. According to LSEG IBES data, S&P 500 earnings are expected to grow 14% in 2025.
On the other hand, inflation remains stubborn, and Wall Street is concerned that a rebound in inflation may cause the Federal Reserve to change its easing cycle. In fact, the stock market pulled back sharply on Wednesday after the Federal Reserve predicted a reduction in interest rate cuts next year and prepared for stronger inflation.
If Trump imposes tariffs on imported goods from the US, this will cause consumer prices to rise, and this possibility is likely to increase. Meanwhile, US stock valuations are at their highest level in more than three years, which increases the possibility of market turmoil.
Garrett Melson, portfolio strategist at Asset Management in Paris, France, said, “Since rebounding from a low point at the end of 2022, we have made great strides. The increase is quite impressive. Market sentiment is definitely very fervent right now, but as you begin to get through the year, you may need to control it a little bit.” He believes that if the return rate of the previous two years is not achieved, US stocks may still achieve steady growth of about 10% in 2025.
Wall Street companies mostly predict that the stock market will rise next year. Their year-end price target for the S&P 500 index is between 6,000 and 7,000 points. The index recently hovered around 5,900 points.
Optimistic investors can point out that the bull market is neither “old” nor excessive by historical standards.
Keith Lerner, co-chief investment officer at Truist Consulting Services, said that the current bull market in the S&P 500 index, which began in October 2022, has lasted less than half of the average duration of the previous 10 bull markets. Lerner said that in this bull market, the S&P 500 index rose by about 64%, which is lower than the median increase of 108% and the average increase of 184% in the previous bull market.
Lerner said, “If you look at the long term, yes, we've gone up a lot, but if you look at a typical bull market, it shows that we have room for further growth.”
Other historical signs also bode well for the future. Since 1950, in the 8 examples where the S&P 500 index achieved an annual increase of 20% for two consecutive years, the average increase was 12.3%, compared with an overall average increase of 9.3% during the same period. The index rose 6 times out of 8.
The US economy withstands the test of the Federal Reserve's rate hike
Underpinning the optimism, Wall Street generally believes that the economy has withstood the interest rate hike implemented by the Federal Reserve starting in 2022 to curb inflation.
A survey conducted by Paris Asset Management in recent weeks found that 73% of institutional investors said the US will avoid a recession in 2025. This is quite different from the situation a year ago, when 62% of investors predicted a recession in the coming year.
The Citigroup Economic Accident Index, which measures economic data and expected performance, has been steadily positive over the past two months, which is another positive sign for investors.
Trump is expected to implement growth-oriented policies, including tax cuts and deregulation, which also increases expectations for strong economic growth.
Sameer Samana, senior global market strategist at the Wells Fargo Investment Research Institute, said, “We ended 2024 on a good note. We think 2025 will experience a certain degree of re-acceleration. The market is often ahead of the economy, so they will prepare for a new economic acceleration as soon as possible.”
However, the stock was also highly valued at the end of 2024: according to LSEG, the expected price-earnings ratio of the S&P 500 over the next 12 months is close to 22 times. This is well above its long-term average of 15.8 and not far from the level of 22.6 reached earlier this month, the highest level since early 2021.
Investors believe that valuations can remain high for a long period of time, which does not necessarily indicate an imminent decline. But future gains are likely to depend more on earnings growth, and higher valuations may make stocks more vulnerable to any disappointments.
Risks include policy uncertainty, such as Trump's expected to push for higher import tariffs on other trading partners, which analysts estimate could hurt corporate profits. Higher tariffs may also drive up inflation, which is another concern for investors. Since reaching a 40-year high in 2022, the increase in inflation has declined sharply, but it is still above the Federal Reserve's 2% target.
Michael Reynolds, Glenmede's vice president in charge of investment strategy, said, “How low the Federal Reserve can reduce interest rates will actually depend on how low inflation is reduced. If we see that inflation stabilizes around 3%, we don't think the Fed will take such aggressive measures next year.”
Glenmede advises investors to take a neutral stance on overall portfolio risk, including stocks. Reynolds said:
“Investors should remain cautiously optimistic. We have an economy showing signs of late expansion, and a fairly high valuation.”
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