As the stock market wraps up a second straight year of 20% gains, the bar is high for the rally to continue into 2025.
“Investors will have to grapple with a market pricing in a lot of good news,” LPL Research said in a note this week. “Positive surprises that drove stocks higher in the last year may be more difficult to come by in the year ahead.”
According to the company, the stock can extend its record rally next year if it aligns 4 points.
It may seem obvious, but for the stock market gains to continue, the economy needs to stay resilient, and that means the US needs to sidestep 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.”
With US GDP tracking at an annualized growth rate of about 3%, it seems only an external shock could jolt the economy significantly lower. One economist even gave a 0% chance of a recession for next year.
Stocks have seen a sharp increase in volatility from the issue 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 baseline calls for at least two cuts next year as inflation continues to fall, which would be smart for the stock,” the company said.
Although expectations for rate cuts by 2025 have diminished, the Federal Reserve is still on track to reduce borrowing costs.
And absent a recession, the S&P 500 has historically delivered solid returns after a Fed-cutting cycle.
“The S&P 500 has produced modest gains of 5.5%, on average, during the 12 months following the initial cut of a Fed cycle, with gains typically double that in the absence of a recession,” LPL said.
The Fed delivered its first interest rate cut of the cycle in September.
This isn’t the first time markets have experienced volatile trading due to a recalibration of interest rate expectations.
Heading into 2024, markets were expecting more than six interest rate cuts from the Fed. They only delivered three rate cuts, including a 50-basis point jumbo cut. The stock market ultimately did just fine.
Corporate earnings are the driving force behind rising stock prices in the long term, so it should be no surprise that LPL is watching for continued earnings strength in 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.