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The stock market looks destined to close out another 20 percent-plus year on top of last year’s 20 percent-plus year.  A cluster of two outstanding years back to back is pretty rare, but odds favor it will happen.  According to Yahoo Finance, Since 1950, there have been eight times the S&P 500 gains 20% or more two years in a row. The third year saw positive gains in six of those eight times, with an overall average and median return of 12% and 13%, respectively.

This history suggests that 2025 will be a decent year but not as good as the past two.

Price action remains favorable, with a cluster of new highs and a breakout in the NYSE advance-decline line (more shares are advancing in price than declining).

Stocks showed little hesitation after the election. This was powered both by the Fed’s pivot towards lower interest rates and a general feeling that Trump would be suitable for stocks and the economy. Most market participants rejoiced at promises of lower taxes, reduced regulations, and a cut in the federal budget and the subsequent deficit.  This would be a plus if we could avoid sliding into War III.

Most polls show widespread favorability towards Trump and his post-election cabinet selections. True, many will have to get through the Senate. While some might be rejected, the feeling is most will make it through a Republican Senate, even with some whining RINOs.

Consequently, the public belief that stocks will continue to new highs next year hit 56%, the highest reading in history. With all this good news and the favorable reaction in the markets, what does a worry wart have to fret about? Unfortunately, quite a bit.

As the investment advisory Motley Fool recently put it: “Despite all three major stock indexes soaring after Election Day, President-Elect Trump will be entering the Oval Office under extremely challenging circumstances. More specifically, no incoming president has ever inherited a stock market as pricey as the one we’re looking at today.”

Not only is the market very expensive based on many traditional metrics, but investor sentiment is sky-high, and stocks have been pumped by massive liquidity. 

One thing is the pervasive nature of the good news and the bullish spirit. Those who watch sentiment get concerned when bullishness is so pervasive, extreme, and one-sided. They argue that since everyone feels that way and is placing their stock bets in accordance with these bullish feelings, all this good vibe is currently in the price structure. So enthused is the public that the percentage of stocks as a portion of household wealth is at the highest level ever measured. In short, stocks are getting priced to perfection, a condition rarely, if ever, delivered by mortal beings.  That could leave equities vulnerable to disappointment.

Corporate executives have turned towards being big sellers while the public remains a big buyer. Why would that be a problem?  It might not be a problem, but corporate leaders generally know their businesses better than the public. Typically, it is not a good sign to see insiders selling and the public buying.  What do they know we don’t?

The Fed has pivoted but may have done so prematurely. As we have explained before, the Fed is supposedly lowering interest rates, but market interest rates for longer-dated government bonds are rising instead. The same can be said for mortgage rates. The bond market has decided to defy the Fed. Why?

The market could see little relief on the inflation front and expect the FED to slow or soon reverse on the premature pivot.

It is a pretty rare occurrence, but two things might be bothering the bond market. One is the enormous funding burden, simply the massive supply of government bonds that must be sold to fund a deficit that is so large and growing so fast. Secondly, the FED said they wanted inflation at 2% after losing control of inflation, which got to 9%, and then told us all that it was “transitory.” Their credibility is on the line, and three of their favorite inflation indicators have stopped falling and are starting to rise or march sideways, well above their 2% target. It appears they may have declared victory over inflation too early.

Many are also worried that enormous monetary and fiscal stimulus has created the present conditions the stock market enjoys. Other than wartime or recession (like the COVID lockdown), we have never seen this kind of Federal monetary stimulation during peacetime prosperity. Given the soaring deficit and the interest costs on that deficit, this can’t continue. The question for markets is this: If you take away the punchbowl, will the partygoers be as happy as they are at present?

As mentioned before, heavy leverage use in the private sector is showing some signs of difficulty. Lower-quality car paper is in trouble, rising delinquencies on credit card debt are evident, and trouble in the real estate sector all hint at credit distress. The fact that interest rates are rising rather than falling as the FED commanded will place additional burdens on the overextended debtor.

However, among other reasons, Trump was elected to trim spending and reverse the current suicidal course of debt and spending. He was elected to be a disruptor because all this inflationary stimulus has helped chiefly the very rich who own all the appreciating assets. But it is killing the middle and lower class. Many came to feel that 12 of 16 years of Democrat rule were not a good deal for them, hence the populist revolt. Therefore, are current high stock prices justified if Trump takes away much of this stimulus?

In addition to disrupting the pattern of chronic deficits, Trump is expected to do something with tariffs and trade.  China is already in recession, and their recent great pivot towards easy money has not proven to be the growth elixir the world expected.  Both their economy and markets continue to look rather nasty.  Europe, Japan, and Canada are not in good shape, and the leftward tilt of Mexico looks to have ruined their chance of being the big winner in re-shoring industries once located in China.

In short, most of America’s trading partners are not in good shape, and a tariff war could harm world business conditions. We agree that America has negotiated poor trade deals, but can we export much if the rest of the world goes into recession? We are well past the stage where the US is immune from adverse developments among our major trading partners.

There is a risk of being a disruptor, even if the disruption is sorely needed. We are not sure the market has started to price any of the above-mentioned difficulties into the price structure.  Policy choices could be contradictive.

Tax cuts and deregulation could be stimulative. However, a trade war, persistent inflation, and rising interest rates could be negative.

Critics have also long argued that the market is costly by almost any historical metric. We mentioned before that Warren Buffet is hoarding cash like crazy. Speculative juices are running high, with record volumes in options trading and soaring cryptocurrencies. True, some of those conditions have been with us for some time, and the market does not seem to care. That may continue until valuation suddenly matters once again.

Speaking personally, the very favorable price action has kept us reasonably heavy in equities despite the grumbling by more bearish forecasters. But we know that much of what they are saying is true, making us nervous.

After Thanksgiving, the markets tend to finish the year on the upside. However, as we peer into 2025, we think the market will have to deal with some severe issues and distortions. If the price trend begins to show weakness, we will not be waiting for a signed invitation to take some more risk off the table.

We are impressed with Trump and the crew he has selected so far. However, as mentioned earlier, while disruption is necessary, it carries the risk of unpredictable outcomes. Some of those outcomes could be pretty good, and some could prove to be surprisingly bad. Currently, the market seems priced only for the best outcomes.

As they say, hope is not necessarily a good plan.