Investors are Becoming More Bullish–and That is a Warning Sign

As investors become more optimistic, it raises the bar for an upside surprise. Mitch discusses investor sentiment and the ‘policy uncertainty’ that lies ahead.

Investors are Becoming More Optimistic. That’s a Warning Sign The current bull market started in October 2022, following stocks’ negative response to the rapid inflation increase and rising interest rates on both the short and long end of the curve. Just over two years have passed since the market started rallying, and in that time, I can confidently say the “wall of worry” has been alive and well. Consider that for all of 2023 and most of 2024, it seemed like every economic and market-based conversation revolved around inflation. And for good reason—inflation had soared, and U.S. households were feeling the sting of higher prices across a wide array of goods and services. To make matters more unpleasant, interest rates were increasing, which raised the cost of borrowing and shut many people out of the housing market. Then there were the bank failures in March 2023, which many investors worried would reverberate across the financial system and cause a repeat of 2008. A handful of key regional banks failed, and many predictions around that time centered around which ‘shoe would drop’ next. Will Inflation and Interest Rates Shape the Q1 Market? The current bull market has thrived despite inflation, rising interest rates, and banking disruptions. But what will 2025 hold for investors? To navigate the future, gaining clear insights is vital. From inflation’s effects on budgets to shifting interest rates, staying informed is crucial for seizing opportunities and managing risk. That’s why we’ve created our January 2025 Stock Market Outlook Report 1—your essential guide for confident investment decisions this quarter. Inside, you’ll discover: Zacks Rank S&P 500 sector picks to pinpoint potential market leaders. Asset allocation guidelines for today’s market environment. Expert forecasts for inflation, rates, and economic trends. Industry tables and rankings to help you spot opportunities. Buy-side and sell-side consensus insights at a glance. And much more! If you have $500,000 or more to invest and want to take charge of your financial journey, click the link below to get your free report today! IT’S FREE. Download the Just-Released January 2025 Stock Market Outlook 1 In 2024, the unemployment rate started to tick higher, and there was regular mention of the “Sahm rule”—which connects recession probability with a 0.5% increase in the three-month moving average of the unemployment rate (compared to its lowest point in the previous year). The yield curve was also inverted throughout this period, which has historically been a reliable indicator of economic weakness. And I haven’t even mentioned election uncertainty. These fears kept accumulating from 2022 to 2024, which I think created an ideal setup for a strong market rally (chart below). Expectations were low, investors were deeply skeptical, and the “wall of worry” was intact and arguably growing. That sets up an environment where the economy and corporate earnings did not need to outperform by much to send stocks higher. When the bar is set that low, it’s easy to overcome. And that’s what corporations and the economy did, led by mega-cap technology companies and all the economic activity generated by the artificial intelligence theme. The Wall of Worry Has Been Firmly Intact for 2+ Years, and Stocks Have Soared Source: Federal Reserve Bank of St. Louis 2 I’ve noticed that sentiment is starting to shift. Inflation worries have largely subsided, jobs market weakness appears to be more connected to the surge in immigration than to layoffs and corporate downsizing, and economic growth surprised to the upside in arguably every quarter of 2024. In other words, there are plenty of reasons to be optimistic, and it’s starting to sift through to markets. In November, the Conference Board reported that a record high number of investors3 and consumers (57.2%) believed that stock prices would rise in the year ahead. In December, the number dropped to 52.9%, but that’s still elevated relative to previous years. Only a quarter of respondents expected the market to drop. A separate measure of sentiment published by Investors Intelligence found that 70% of traders were bullish on equities and over 60% of advisors had a positive outlook. It’s early days in the new administration, but I think it’s fair to say that consensus is starting to form around the idea deregulation and the full extension of tax cuts could boost economic activity, business investment, and profits. In this context, a more optimistic outlook may be justified. The challenge is that high and rising expectations for the cyclical upturn raise the bar for an upside surprise, which is made even harder by the fact that the S&P 500 traded at 22x 2025 earnings at the start of the year. That’s a tough setup, in my view, and one that opens the door for any policy misstep, perceived economic weakness, or earnings misses to have an outsized effect on downside volatility. Bottom Line for Investors I want to be clear that just because I think sentiment is becoming more optimistic, this does not mean I think the end of this bull market is near. There is still a healthy dose of ‘policy uncertainty’ in markets, and investors still appear to be concerned about valuations at current levels especially given long-duration Treasury yields. The inflation story and geopolitical concerns also continue to swirl. There’s also a great chance the U.S. economy and corporations do, in fact, surprise to the upside. Relative to global competitors, I think there is a straightforward argument that the U.S. is the best place to do business right now—economic growth is strong, AI ‘hyper-scalers’ and major technology players have delivered a rapid pace of earnings growth that should broaden out to other companies and sectors in the new year, and the labor market and U.S. consumer are on solid footing. Just because the bar is high, doesn’t mean the U.S. economy can’t clear it. As these conditions evolve, staying ahead is critical. Our Just-Released January 2025 Stock Market Outlook Report 4 equips you with the insights to navigate the market’s uncertainties and capitalize on emerging opportunities. Inside, we break down the key factors driving optimism and provide actionable forecasts, including: Zacks Rank S&P 500 sector picks Current asset allocation guidelines Zacks forecasts for the months ahead Zacks Rank industry tables Buy-side and sell-side consensus at a glance And much more! If you have $500,000 or more to invest and want to learn more about these forecasts, click the link below to get your free report today! FREE Download – Zacks’ January 2025 Stock Market Outlook Report 4 About Zacks Investment Management Zacks Investment Management was born out of one of the country’s largest providers of independent research, Zacks Investment Research. Our independent research capabilities from our parent company truly distinguish us from other wealth management firms - our strategies are derived from research and innovation, including the proprietary Zacks Rank stock selection model, earnings surprise and estimate revision factors. At Zacks Investment Management, we work with clients with $500,000 or more to invest, and we use this independent research, 35+ years of investment management experience, and tools we’ve developed to design customized investment portfolios based on each client’s individual needs. 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