Market Rally Hides Looming Risks
The S&P 500 has reached new heights, fueled by President Trump’s pro-business agenda. However, investors may be overlooking significant risks to the market, including inflation and high interest rates. Strategists warn that the focus on Trump’s policies may distract from these underlying issues, potentially leading to a 10% drawdown in stock prices in the coming months.
Inflation Concerns
Bond yields have been creeping up, with the 10-year Treasury yield rising to 4.65% on Friday morning. This suggests that bond markets are repricing on the outlook for interest rates to remain elevated. Trump’s address to the World Economic Forum, in which he demanded lower interest rates, did little to stem the tide. Clark Geranan, chief market strategist at CalBay Investments, believes that markets are too distracted by Trump’s legislative changes to pay attention to the inflation picture.
Distracted Investors
Investors appear to be betting that Trump’s pro-growth policies will outweigh the negative impact of higher inflation. Paul Stanley, chief investment officer of Granite Bay Wealth Management, notes that investors think Trump will slash taxes and dial back regulation during his second term, boosting stock prices. However, economists warn that some of Trump’s policies could stoke inflation and keep interest rates higher for longer.
Tariffs and Trade Wars
Trump’s orders this week were softer than feared, lifting stock prices. However, the threat of a damaging trade war remains, and it’s unclear what shape tariffs will take. Inflation has accelerated in recent months, with consumer prices rising 2.9% year-over-year in December, the highest level since July.
Expert Predictions
Geranan predicts that inflation could remain stuck at around 3% this year, and the Fed may only cut rates once or not at all in 2025. He’s hedging against an inflation pop and wouldn’t be surprised to see a sell-off happen sometime in the next six months, taking stock prices down as much as 10%. Stanley also considers a 10% stock pullback to be a strong possibility, citing the likelihood of extreme volatility in one direction or another.
Investor Sentiment
Despite these warnings, investors remain broadly optimistic about stocks. According to the AAII’s latest Investor Sentiment Survey, 43% of investors said they were bullish on the stock market over the next six months, up 18 percentage points from the prior week. However, strategists urge caution, warning that investors should not ignore inflation at their own risk.
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