The US stock market is on a roll. The S&P 500 index closed 2024 up 23 percent, marking its second consecutive annual gain above 20 percent. This year, the average forecast on Wall Street is for about an additional 10 percent rise. Households are also optimistic: The share of Americans who expect stock prices to rise is at its highest level in decades.
The exuberance is jarring for two reasons. First, most economists expect President-elect Donald Trump’s “Maganomics” agenda to have a negative impact on US economic growth, according to the Financial Times. annual survey. Second, US asset valuations are already quite high. Excluding the peak of the dot-com bubble, stocks’ cyclically adjusted price-earnings ratios are near their most expensive level in more than a century. Optimism about artificial intelligence is largely behind the rise. So can US stocks really maintain their uptrend in 2025?
It is possible. For starters, while economic growth and stock market performance are related, they don’t always align neatly. Vibrations matter. U.S. stocks rose after the November election. That partly reflects the belief that a business-friendly Trump administration would not jeopardize the market’s rally. Then, even if economic activity weakens this year, investors still want exposure to AI, given faith in its transformative potential. If both Trump’s and tech’s optimism pay off, then stocks could continue to rise.
Economists’ forecasts also appear to be placing more emphasis on the inflationary and cost-increasing effects of Trump’s tariff agenda, relative to his plan to reduce bureaucracy and taxes, which would support business margins. However, if the president-elect’s enthusiasm for import taxes turns out to be more rhetoric than reality, then the economic backdrop could support financial markets. It is possible that the US Federal Reserve could cut interest rates further and more quickly (although depending on how much fiscal policy is eased).
But how can investors have any conviction about what Trump will actually do? On Mondays, swinging markets after the president-elect refuted an earlier news report that claimed he would soften his tariff plans. He has a tendency to shoot from the hip on important political decisions, via social media. His plans to deregulate financial markets could also foster risks to stability. Cryptocurrencies have increased since the elections. The booming private equity market, which has worried regulators about its opacity, is waiting to lobby the incoming administration for more widespread adoption by investors.
Signs of fragility are also emerging in US markets. Stock and corporate bond valuations are stretched thin, and investors are taking on more risk. Last year, Wall Street’s appetite for profitability sparked the biggest trading frenzy. complex debt products since the period before the financial crisis. The concentration of investment in high-performing stocks linked to AI is also a cause for concern. The weight of the top 10 stocks in the S&P 500 is at an all-time high. AI earnings may remain strong, but a single weaker-than-expected quarterly tech result could still cause a huge surprise.
in a monday speechFederal Reserve Governor Lisa Cook warned that financial markets can be “perfectly priced and therefore susceptible to large declines, which could be the result of bad economic news or a change in investor sentiment.” ”. The release of nonfarm payrolls data on Friday will be the first big test for traders this year. It won’t be the last. The combination of Trump’s capriciousness and frothy-looking markets is a recipe for volatility. Even investors with a decidedly optimistic outlook should prepare for a bumpy ride.