Markets have rallied significantly from their April lows, and we are now in a situation where there are healthy year-to-date (YTD) gains in almost all major asset classes.1 Looking at the remainder of 2025, we wanted to provide a balanced look on the current state of the market:
Reasons to remain bullish:
- Corporations are doing well: Earnings growth is solid, dealmaking activity picking up, and companies have been significant buyers of their own shares. For Q2 2025, S&P 500 earnings growth was up 12%, its third consecutive quarter of double-digit growth.2 Investment banks have been adding staff as merger & acquisition and equity capital markets deal volumes are up 40% this summer from a year ago.3 US corporations have bought back more than $1 trillion of their own shares YTD, the fastest pace on record, implying that management teams believe shares are still undervalued.4
- AI revolution: Advances in artificial intelligence have the potential to significantly increase productivity over the next decade, with most believing we are still in the early innings of this transformational technology. Increased automation and efficiency gains should lead to strong revenue and margin growth across multiple sectors. The stock market is forward looking, so while current valuations may look expensive, today’s prices could be seen as a bargain in a few years if this revenue and margin growth comes to fruition.
- Falling interest rates: The Federal Reserve is currently expected to lower short-term interest rates by roughly 1.0% in the next 12 months (from 4.0% to 3.0%).5 When rates decline, borrowing costs fall, capital becomes cheaper, and valuation multiples can expand. In fact, when the Fed cuts rates within 2% of an all-time high, as they did on September 17, the next 12 months S&P 500 performance has been positive in each of the past 21 occasions.6
Reasons to be cautious:
- Change in AI sentiment: Investment in artificial intelligence is a significant driver of the US economy and stock market, with AI-related capital expenditures now totaling hundreds of billions per year and AI-related stocks making up more than half the S&P 500’s YTD gains.7,8 In contrast, many other areas of the economy seem to be operating at or near recession levels, for example weak job growth,9 manufacturing contracting for over 2 years,10 and auto & credit card delinquencies both extreme vs. history.11 Therefore, a change in AI sentiment from its current optimism would be a clear negative for the economy and market. Remember that in the 1990s/2000s, the internet was a revolutionary technology that significantly increased US productivity and transformed the economy, but it was overhyped in 1999-2000 leading to a large equity market decline as stocks adjusted to the still positive reality. While AI-related stocks today generally show better quality metrics and less-extreme valuations than their Dotcom bubble counterparts, current AI optimism could be excessive even if the technology ultimately succeeds.
- Inflation re-acceleration: With 4-5 cuts expected over the next 12 months already priced into the market and rate volatility low, interest rates have been a key driver of recent equity market strength.12 If inflation re-accelerates, whether due to tariffs or some other reason, such that the Fed feels they cannot follow through with these expected cuts, it could undermine this stable rate environment and have investors demanding a higher risk premium for their assets (meaning lower prices today).
- Valuations: The S&P 500 is currently trading at historically elevated levels on most valuation metrics, meaning that investors expect a benign growth environment in the coming years.13 Similarly, credit spreads on corporate bonds are near historical lows, meaning that corporations can currently borrow at rates only slightly higher than Treasuries, despite having a greater chance of default.14 This means that if aggregate earnings growth fails to meet projections, or investors become concerned about a recession or rising corporate defaults, this disappointment will likely result in a correction lower in market prices. High valuations are not a guarantee that prices will fall – the future can always turn out to be better than current expectations – but it raises the probability of lower than average returns because of the high starting point.
Bottom line:
As is usually the case, there are currently legitimate grounds to be optimistic or pessimistic on the market, depending on which of the above reasons one chooses to put the most weight on. We continue to urge clients to stick to their long-term plans, which means not getting too optimistic in good times or too pessimistic when something negative happens. By staying the course and remaining rationale and balanced as to the risks inherent to investing, you maximize your chances of long-term success.
Please reach out to your GGS advisor for further information regarding these topics or any other questions we can assist you with.