Is a US market correction inevitable?

The year 2025 looks promising, marked by minimal layoffs, a relative decline in inflation, and gasoline and raw material prices staying within acceptable limits. Most significantly, wages are growing faster than prices, suggesting the potential for increased consumption and economic growth.

US economists almost agreed on this perspective, as the economy's fundamentals appear solid. Consequently, fears of a recession that dominated 2024 have subsided, giving rise to debates about whether the highly bullish US equity market will continue its upward trajectory or face a correction—or even worse, a downturn into a bear market.

Healthy Yet, However 

David Kelly, Chief Global Strategist at JP Morgan, warns that despite the economy's strong signs, he fears a "bubble." He points to the clear overvaluation of many assets, particularly in the US stock market and cryptocurrency market. The increasing correlation between these two markets poses risks for stocks, especially given the volatility in cryptocurrencies.

Kelly remarks that "many castles have been built in the air based on this stable economy," particularly regarding valuations of large US stocks and Bitcoin. He draws parallels to the dot-com bubble, where internet company valuations grew unchecked throughout the 1990s before the bubble burst in the late '90s and early 2000s.

Concerns Over Asset Inflation

The sharp rise in the US stock market relative to global markets highlights potential asset inflation. By the end of 2023, the US market accounted for 59% of the global stock market's value, climbing to nearly 70% by the end of 2024. This surge reflects significant inflows of domestic and international funds, possibly at the expense of other markets, raising concerns about a US-centric bubble.

The S&P 500 reached a staggering $10 trillion market capitalization in 2024 but saw notable growth slowdown in the year's second half, with gains of just over 6%, compared to an overall 26% annual increase. This deceleration reflects investor caution despite optimistic forecasts, such as those from Bank of America predicting record levels in the future.

The technology sector's rapid rise is another area of concern. The Nasdaq index, fueled by AI-driven growth and its "Magnificent Seven" companies—Alphabet, Apple, Tesla, Microsoft, Nvidia, Amazon, and Meta—grew 29% in 2024, following a 43% increase in 2023. Some experts view the doubling of market value for several tech stocks over two years as unsustainable.

These seven companies have significantly influenced US market performance. While the overall stock market rose 58% in 2023 and 2024 (including dividends), excluding their impact reduces the gain to 24%, signaling that the major part of stock rallies is linked to some companies that are deemed by many overvalued, in light of a standard P/E for most of them.

Contradictory Signals

A UBS report released in December 2024 highlighted conflicting signals, suggesting the US market could rise 15-20% further before the current bubble bursts. However, it warns that this time is different. This is the logic that prevailed every time a stock or an asset bubble took place.

The logic of "this time is different" prevailed before the burst of previous bubbles, such as the '70s Nifty Fifty and Japan's late-'80s bubble. The report cautions that when bubbles burst, investors may lose up to 80% of their funds, especially those holding overhyped "popular" stocks.

Optimistic projections, like the S&P 500 potentially reaching 6,500 to 7,000 points in 2025, could further inflate asset prices, making a future correction more severe.

Some believe a correction or bear market is delayed, citing continued investment inflows into the US market amid struggling European and Asian economies and the lingering effects of the Russia-Ukraine war on the Eurozone, particularly Germany.

Buffett’s Moves and Luxury Spending

Renowned investor Warren Buffett has reduced his holdings in major companies, including Apple, and amassed a record $350 billion cash reserve, signaling his anticipation of a market downturn.

Luxury goods sales also serve as an economic indicator. Companies like LVMH reported a 14% decline in stock value in late 2024 due to slowing sales, further signaling caution among wealthy consumers.

Despite this, investment advisor Ed Yardeni remains cautiously optimistic, dismissing fears of a US bear market. He predicts a 10-15% market correction rather than a 20% decline, seeing such a correction as "healthy" for reallocating funds from overvalued to undervalued stocks.

Conclusion

A US market correction seems more likely amid continued disproportionate advance, reminiscent of the Clinton-era boom in the 1990s. However, uncertainty remains about its timing. While major financial institutions believe a correction is "delayed," actions by leading investors hint it may be imminent.

Sources: Argaam, CNN, FT, The New York Times, The Economist