As the stock market completes a second consecutive year of 20% gains, the bar is high for the rally to continue through 2025.
“Investors will have to deal with a market full of smart news,” LPL Research said in a note this week. “The positive surprises that drove stocks higher last year are likely to be more difficult to materialize in the coming year. “
According to the firm, stocks can extend their record rally into next year if four important factors align.
This may seem obvious, but for gains in the stock market to continue, the economy will have to remain resilient, meaning the U. S. will have to avoid a recession again in 2025.
Historical knowledge suggests that the third year of a bull market can be strong, with average gains around 5%, according to LPL. But this is only imaginable if a recession is avoided.
“In the absence of a recession, the odds that a two-year-old bull market gets to three are quite good,” LPL said. “The bulls that didn’t make it through a third year were ended by recessions, an overly aggressive Fed, or, in the case of 1987, excessive speculation.”
Given that the US GDP follows an annualized expansion rate of around 3%, it seems that an external surprise can cause a significant decline in the economy. One economist even put forward a 0% chance of a recession occurring next year.
Stocks have seen a sharp increase in problematic volatility since Fed Chair Jerome Powell announced an aggressive interest rate cut at the central bank’s FOMC meeting earlier this month.
But it’s important to note that the Fed is still dovish, according to LPL.
“LPL Research’s base situation calls for at least two cuts next year as inflation continues to fall, which would be smart for stocks,” the company said.
Although expectations of rate cuts for 2025 have eased, the Federal Reserve is still on track to reduce borrowing costs.
And absent a recession, the S&P 500 has traditionally generated strong returns after a cycle of Federal Reserve cuts.
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The Fed delivered its first interest rate cut of the cycle in September.
This is the first time that markets have experienced volatile trading due to a recalibration of interest rate expectations.
Looking ahead to 2024, markets were expecting more than six interest rate cuts from the Federal Reserve. They only made three rate cuts, adding a giant 50 basis point cut. In the end, the stock market performed well.
Business profits are the driving force behind emerging long-term inventory costs. So it’s no surprise that LPL expects its profits to continue well into the new year.
“When valuations are as high as they are currently, earnings growth is typically required to lift stock prices. Expect 2025 to be one of those years,” LPL said.