Will S&P 500 Keep Soaring in 2025? Three Key Risks to Watch
1min read As 2024 winds down, U.S. stock market investors have enjoyed substantial gains, with the S&P 500 reaching record highs. But can this momentum continue into 2025? Henry Allen, a macro strategist at Deutsche Bank, warns that elevated valuations may limit the room for further growth. He identifies three major risks that could hinder the stock market next year.
1. Economic Downturn Risks
Allen highlights that a weaker-than-expected U.S. economy poses a significant risk to equities. For instance, in early August, a wave of sell-offs hit the market following disappointing jobs data and concerns over the impact of high interest rates on economic growth.
Looking ahead, the lagged effects of sustained high rates could manifest more prominently, potentially tipping the economy into recession. Adding to the challenge, this year's strong market performance has set a high bar for expectations. Wall Street forecasts GDP growth above 2% for 2025, leaving little room for economic surprises to exceed expectations.
2. Geopolitical Uncertainty
Geopolitical tensions remain a critical concern. Earlier this year, heightened tensions in the Middle East briefly sent oil prices surging and stocks tumbling.
Allen notes that markets are highly sensitive to any escalation in geopolitical conflicts. While past fears, such as a potential Middle East crisis, did not materialize, further conflicts or major escalations—akin to the shockwaves from Russia's invasion of Ukraine in 2022—could trigger sharp sell-offs.
3. Inflation Pressures
While U.S. inflation has cooled significantly from its peak, it remains above the Federal Reserve's 2% target, with sticky categories like housing and services keeping price pressures elevated.
Should inflation persist at high levels, the Fed may keep restrictive rates for longer, which could dampen economic growth and corporate profits. Additionally, policies proposed by President-elect Donald Trump may exacerbate inflationary pressures, complicating the outlook further.
Investor Sentiment: Overconfidence?
According to the latest AAII Investor Sentiment Survey, only 33% of investors are bearish on the market over the next six months, and most major banks remain optimistic in their forecasts for 2025. However, Allen cautions that such high levels of optimism can be a double-edged sword. History shows that overconfidence often precedes market corrections.
Conclusion
While the U.S. stock market has been resilient in 2025, several risks loom for 2025, from economic challenges and geopolitical shocks to persistent inflation. Investors should remain cautious, balancing optimism with an awareness of potential downside risks. Vigilance will be key in a market that may not deliver the same easy gains.