The potential threats that the stock market poses for the year 2025 warrant attention.
The potential threats that the stock market poses for the year 2025 warrant attention.
Wall Street's outstanding returns – the strongest consecutive years since the vibrant Clinton era of the late 90s – have boosted consumer confidence and urged them to spend without restraint. However, some apprehensions are rising in certain circles about potential overshooting, with doubts about the grounding of certain stock prices in reality. There's a concern these conditions might pave the way for a market drop severe enough to jeopardize the overall economy.
Mark Zandi, chief economist at Moody's Analytics, voiced his concerns to CNN, stating, "The stock market is pricing in nothing but perpetual blue skies and sunshine." He added, "The market is extremely expensive, bordered on excessively pricey."
The Nasdaq, fueled by artificial intelligence advancements and the powerful group of tech giants, skyrocketed 29% last year, building upon the exceptional advance of 43% in 2023.
The S&P 500 experienced a staggering $10 trillion increase in value last year, as per S&P Dow Jones Indices. Despite a recent retreat in markets, Zandi cautions about a steep decline, possibly surpassing 20%. The Moody's economist hasn't felt this anxious about overvalued markets since the late 90s, during the inflating of the dot-com bubble.
Although Zandi isn't forecasting an economic collapse on the same scale as the dot-com bubble burst, he warns a market drop today would inflict serious harm on the US economy. If Americans suddenly observed the plummeting worth of their investment portfolios, fragile confidence would be damaged. This would weaken both the ability and willingness to spend – a crucial factor in an economy where consumer spending continues to be the primary driver.
“The run-up in stock values has contributed significantly to the economy’s success. It’s stimulated a lot of spending. The wealth effects are rather potent,” he said. “But if the stock market fell, and persisted for an extended period, that would sap the vigor from high-income spending. And that poses a threat to the economy.”
‘Not grounded in reality’
Economists usually perceive a positive start to the year. Job layoffs are low. Inflation has dwindled. Wages are rising faster than prices. Gas prices are stable.
However, David Kelly, chief global strategist at JPMorgan Asset Management, highlighted the danger of high valuations that make financial markets susceptible to a sudden drop.
“I’m worried about asset bubbles,” Kelly told CNN. “Lots of castles have been constructed on the solid foundation of this stable economy.”
Specifically, Kelly focused on high valuations in large-cap US stocks and non-reality-tethered assets like bitcoin.
“You could witness a significant correction in the near future in things that aren’t grounded in reality,” he said. “There are numerous frothy markets out there which might take a hit. Investors need to think seriously about the risk they are taking.”
Predicting the stock market is notoriously challenging.
History reveals that overvalued stocks can persist – or inflate even further – for quite some time. Recall the internet companies that gained value despite having no revenue in the late 90s before reality set in around 2000.
Furthermore, resisting this relentless stock market surge has proven costly. Not even the most severe inflation crisis in four decades and the most aggressive Federal Reserve since Paul Volcker's era managed to curb the ongoing bull market.
Bubble warning from UBS
Despite cracking signs in the market, investors are closely monitoring the reliance of the overall market on the Magnificent Seven: Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, and Tesla.
Consider that the S&P 500's two-year total return (including dividends) translated to an extremely impressive 58%, but that would have dropped to a meager 24% without the Mag Seven, according to S&P Dow Jones Indices.
US stocks closed the last year on a weak note, and the instability carried over into the first full day of trading in 2025.
UBS recently advised its clients that nearly all seven prerequisites for a market bubble already exist.
“The trouble with a bubble theory is that when a bubble bursts, investors usually lose 80% of their money,” wrote Andrew Garthwaite, UBS global equity strategist, in a December 18 report, citing the bursting of previous bubbles, including the Nifty 50 stocks in the 70s, Japan in the late 80s, and the dot-com bubble.
According to UBS, the bubble preconditions that currently exist include a span of at least 25 years from the last bubble, investment from retail investors, and profits under pressure.
A bubble occurs when there is a narrative of 'it’s different this time around,' generally associated with technical advancements or market dominance, and we have both,” Garthwaite wrote.
The good news is that UBS argues that the market is not yet in a bubble and stocks could “easily” rally another 15% to 20% before moving clearly into bubble territory.
However, it is noteworthy that major Wall Street banks are even utilizing the B-word.
Washington's lawmakers need to find a solution for the debt ceiling issue, which was once again activated on Thursday.
Investors are attempting to grasp the economic strategy of the incoming Trump administration, which involves tax reductions, tariff increases, deregulation, and mass deportations.
The prospect of tariff implementation or significant immigration reform could unsettle investors who are on the lookout for any signs of inflation.
Issues might surface initially in the bond market.
Ed Yardeni, the president of Yardeni Research, an investment advisory firm, cautions that the stock market could be startled if a bond market selloff drives the 10-year Treasury yield close to 5%.
Back in the 1980s, Yardeni coined the term "bond market vigilantes." Currently, investors will be watching closely to see if Congressional Republicans can alleviate concerns regarding rising federal budget deficits.
"If they fail to act and only approve tax cuts, the bond market will freak out," Yardeni said.
'No reason for panic'
Given the recent market gains, it's only natural for some investors to consider a possible turnaround.
Yet, it's also possible that markets remain stable. This would allow corporate earnings to adapt to high valuations.
Yardeni does not foresee a high risk of a bear market, often defined as a 20% drop from previous highs, since a recession does not appear imminent. However, he does predict a 10% to 15% correction.
"I would view it as a buying opportunity, not a reason to panic. It won't be comfortable, but that doesn't mean it won't happen," Yardeni said.
Kristina Hooper, the chief global market strategist at Invesco, advises long-term investors to overlook a market drop as it holds little significance in the overall picture.
"It's insignificant in the grand scheme of things. We could experience a pullback, but it would likely be temporary and perhaps beneficial, preparing the stock market for the next growth phase," Hooper said.
Investors should be cautious about their investments in businesses, given David Kelly's concerns about high valuations making financial markets vulnerable to a sudden drop. The prices of certain assets, like non-reality-tethered ones such as bitcoin, might not be grounded in reality, and investors should consider the risks they are taking.
In this current economic climate, some economists, like Mark Zandi, believe that while the run-up in stock values has stimulated spending and contributed to the economy's success, a significant market drop could weaken high-income spending and pose a threat to the economy.