Investing.com - Elevated stock valuations have left equities open to shocks to an American economy that is less resilient than widely believed, according to analysts at BCA Research.
In 2024, the bellwether S&P 500 index notched an annual increase of 23.3% and logged its best two-year run since 1997-1998, with signs of a relatively healthy US economy, easing inflationary pressures, and an ongoing boom in enthusiasm around artificial intelligence all helping to support gains throughout the year.
In the wake of the uptick, the S&P 500 now trades at more than 21-times forward earnings, 26% above the pre-pandemic average during President-elect Donald Trump's first term, the BCA analysts led by Peter Berezin noted.
Such frothy valuations could expose stocks to possible looming headwinds to the US economy, including the impact on US government debt of President-elect Donald Trump's vow to roll out sweeping import tariffs and deliver new tax cuts, Berezin said.
"The stock market rally is running out of fuel," Berezin added.
In particular, Berezin flagged that these moves could push up the benchmark US 10-year Treasury yield, which has recently touched multi-month highs.
Higher yields can hit stocks by raising borrowing costs for consumers and businesses, and by denting the attractiveness of holding equities compared to bonds.
"The 10-year Treasury yield has risen by nearly one percentage point since the Fed[eral Reserve]’s jumbo rate cut in September, partly on the back of expectations of even bigger budget deficits," Berezin wrote. The Fed slashed interest rates by a full percentage point last year, although officials at the central bank have since indicated they will be cautious before announcing further reductions, giving some lift to Treasury yields.
"A full-blown debt crisis in 2025 is entirely possible at this stage," Berezin said. "And even if a crisis is averted, the fact that bond yields have risen so much lately should cause economic data to surprise to the downside over the coming months."
Meanwhile, Berezin added that investors' sentiment is already "bullish" and positioning has become "very stretched", flagging that this could affect equities because stocks usually perform best "when sentiment is improving and when money is flowing into the [...] market."
"Given the current starting point, however, there is little scope for either of these trends to continue," Berezin argued.