Asset Valuations, Market Risks, and What Could Derail the Rally
Over the past few months, U.S. stocks have hit a string of record highs with minimal turbulence, but investors say the rally could be undermined by three things: persistently high inflation, possible earnings disappointments, and elevated valuations. (1)
As the benchmark index approaches the third anniversary of a bull market that began on October 12, 2022, the S&P 500 posted 25 record closing highs over the past three months. (1)
The S&P 500 has risen nearly 13% in 2025, on track for its third straight year of double-digit gains. Up 33% from its low in April, the index is on track for its best third-quarter performance since 2020. (1)
Looking back over the past five months, the index has yet to pull back as much as 3%, marking its longest streak without such a drop since 2018. (1)
The stock market quickly shook off fears that President Trump’s tariffs would cause a recession, while While Street got boosts from trade deals, solid corporate results, and optimism regarding artificial intelligence. Looking forward, some investors are now confident the Federal Reserve is likely to ease interest rates significantly. (1)
However, with all this in mind, there are still a number of factors and scenarios that could derail the rally.
Bad News Is Good News: “That Paradigm Could Flip With Little Notice”
As of late, bad news seems to be good news for the stock market, with weak job growth and slowing activity in areas like manufacturing bolstering the case for rate cuts, but that paradigm could flip with little notice. (1)
Weak labor market reports prompted the Fed's September 17 rate cut, yet few investors appear to be worried that the jobs situation indicates a significant economic downturn. Any data that causes a rethink of that could easily disturb the market. (1)
Historically, the S&P 500 gained, on average, 11% in the year after the Fed began or resumed rate cuts. In instances of recession, however, equities posted sharp one-year declines despite the easing. (1)
Investors are watching to see whether labor-market weakness slows consumer spending, which currently accounts for over two-thirds of economic activity. (1)
Fed Rate Cuts: If US Growth Remains Strong, It Could Put Pressure on Stocks
On the flip side, if growth in the US remains strong, investors may start to worry that they've priced in Fed rate cuts too aggressively, putting additional pressure on stocks, given how optimistic the market has been about Fed easing in recent weeks. (2)
Aiming to steady a weakening employment picture, the Fed cut rates this past month. Fed fund futures are pricing in at least another full percentage point of easing, or four standard cuts, throughout the next year. (1)
Fed Chair Jerome Powell said near-term risks to inflation are “to the upside,” making a “challenging situation” for the central bank. (1)
High Valuations Make Stocks Vulnerable
The S&P 500 is trading at nearly 23 times forward earnings estimates of constituents, around its highest in five years and well above its 10-year average of 18.7, according to LSEG Datastream. (1)
High valuations in megacap technology and growth stocks that are heavyweights in indexes present a particular risk, especially if doubts emerge surrounding AI investments and spending. (1)
Article Sources:
(1) Krauskopf, Lewis. “Relentless US stocks rally could teeter on inflation, earnings, valuation risks.” Yahoo Finance, September 25, 2025. https://finance.yahoo.com/news/relentless-us-stocks-rally-could-100317992.html?guccounter=1&guce_referrer=aHR0cHM6Ly93d3cuZ29vZ2xlLmNvbS8&guce_referrer_sig=AQAAAMy7Jp9x4f77AZBoNNt5No4OVNoBTJ-GOI-ab68Jlqf74CLZ647cj1fB2s0PRbiwNVzPuhtvFV3fEhSiAf9Szo-NSDMhIxXVlINMQKDglFhq8GJhIVrqNuXxyUC0TyA853-NcTmG5QsM73g8YRYmCTs3Z9j60ppQEFfSYY7e7zeg. Accessed September 25, 2025.
(2) Sor, Jennifer. “Stocks are at record highs. These 2 things could derail the rally.” MSN, September 12, 2025. https://www.msn.com/en-us/money/markets/stocks-are-at-record-highs-these-2-things-could-derail-the-rally/ar-AA1MqrH2?ocid=finance-verthp-feeds/. Accessed September 25, 2025.