"Stock Market Outlook 2025: Warning Signals, Risk of a Crash, or Just Panic?"

Many investors see a dangerous mix brewing on the markets: high valuations on the US stock market, the destabilizing effect of the upcoming Trump administration and an overestimation of the impact of the AI revolution. The risks should not be overlooked, but the opportunities should not be downplayed, argues Ali Masarwah, fund analyst and managing director of financial services provider envestor.

13. January 2025. FRANKFURT (envestor). The pessimists currently have a boost, and their arguments are not bad. With a price/earnings ratio (P/E) of around 23 for the S&P 500, the valuations of US equities are well above the historical average. At the same time, Donald Trump's imminent inauguration is causing additional nervousness. Tariffs are slowing growth, fueling inflation, the deportation of millions of immigrants would further fuel inflation and deprive the US economy of important workers and thus a lot of potential. This is the stuff that downward spirals are made of!

In view of so much gravitas, one is inclined to smile at the optimism of the sunny boys on the stock market as naïve. Many investors continue to rely on the innovative strength of US companies, particularly in the technology sector. The AI revolution promises enormous productivity gains. Companies such as Nvidia, Microsoft and Alphabet are investing billions in AI infrastructure, which has the potential to transform entire industries.

The bulls also emphasize the chances of a second term for Donald Trump. They see his shirt-sleeved appearances and announcements as “opening chess moves” with which he wants to get the best deal for the US vis-à-vis partners (Europe) and competitors (China). With a Republican majority in Congress, tax cuts are easy to implement. The drop in corporate taxes from 21% to as low as 15% will bring about a similar bull market as in Trump's first term, according to the optimists. In view of the prospect of rising corporate profits, the S&P 500 is nowhere near as expensive as it currently appears.

The AI revolution as a growth driver

Investors should view the two poles as extreme scenarios and look for the truth in the middle. The current AI revolution could indeed be as transformative as previous technological upheavals, even if experts such as Jim Covello from Goldman Sachs warn that the high investments in AI may not pay off as quickly as many investors hope. However, this argues more for diversification away from the high weighting of hyperscalers and the Magnificent 7 and less for staying away from the stock market.

But where to put the money? Conservative equity investors, who distinguish between short-term euphoria and long-term potential, are looking towards Europe and Japan, whose markets are valued much more favorably than the US market. However, these regions also have weaker economic growth and much lower technological momentum than the USA. Growth of just 0.9% is forecast for the eurozone in 2025, and 1.2% for Japan. Bold investors could look towards second-tier tech stocks that are gearing up to create the applications in a major AI rollout, now that hyperscalers have loaded up on Nvidia chips.

Why high valuations should be put into perspective

Investors in Germany are particularly inclined to believe the pessimists more than the optimists. A healthy dose of skepticism towards too much market euphoria should be part of every investor's toolkit. However, the fear of a “crash of the century”, which is repeatedly conjured up, is misplaced. High past returns are an indication of future below-average returns and not a tool for predicting share prices.

What does that mean? Allocate less money to the big tech platforms and consider the poorly performing markets. If you diversify your portfolio broadly and rebalance it more or less regularly, you ensure that you don't catch any cluster risks. Europe, Japan, second-line stocks, the S&P 493, emerging markets and digital stocks from the second tier are a sensible allocation on the equity side. Risk diversification is the best reason to start the new stock market year with confidence and composure.

By Ali Masarwah, 13. January, 2025, © envestor.de