By Lewis Krauskopf
NEW YORK (Reuters) -U.S. stocks have hit a string of record highs with minimal turbulence over the past few months, but investors say the rally could be undermined by persistently high inflation, possible earnings disappointments and elevated valuations.
The S&P 500 has posted 25 record closing highs over the past three months and the benchmark index is approaching a third anniversary of a bull market that began on October 12, 2022.
Stocks shook off fears that President Donald Trump’s tariffs would cause a recession. Wall Street got boosts from trade deals, solid corporate results and optimism over artificial intelligence. Now, investors also are confident the Federal Reserve will ease interest rates significantly.
The S&P 500 has risen about 13% in 2025, on track for its third straight year of double-digit gains. It is up 33% since its low for the year in April. The index is on track for its best third-quarter performance since 2020.
Over the past five months, the index has yet to pull back as much as 3%, its longest streak without such a drop since 2018, according to Mark Hackett, chief market strategist at Nationwide.
“I do get a little bit more nervous just about the straight upward momentum in the market,” said Anthony Saglimbene, chief market strategist at Ameriprise Financial. “The market is trading at levels that any kind of unexpected hiccup could cause a near-term dislocation.”
Here are some risks investors say could dent stocks:
INFLATION STAYS HIGH, UNDERMINES RATE-CUT HOPES
The Fed cut rates this month, aiming to steady a weakening employment picture. Fed fund futures are pricing in at least another full percentage point of easing, or four standard cuts, through next year. Fed Chair Jerome Powell has said near-term risks to inflation are to the upside, making for a “challenging situation” for the central bank.
“You have a pretty strong belief in a lot of Fed cuts moving forward … while inflation is not necessarily under control,” said Patrick Ryan, chief investment officer at Madison Investments.
Inflation is still running above the Fed’s 2% target. Meanwhile, “we still haven’t seen the full impact of tariffs yet on end consumer prices,” noted Allen Bond, portfolio manager at Jensen Investment Management.
Should tariffs stoke inflation further, “then the dovish Fed support maybe goes away,” Bond added.
The monthly personal consumption expenditures price index, a key inflation gauge, is due on Friday.
ECONOMY IS WEAKER THAN FEARED
Weak labor market reports prompted the Fed’s 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 roil the market.
Historically, the S&P 500, on average, has gained 11% in the year after the Fed started or resumed rate cuts, according to BMO Capital Markets. In instances of recession, equities posted sharp one-year declines despite the easing.
Investors are watching whether labor-market weakness slows consumer spending, which accounts for over two-thirds of economic activity. A top market risk is “a deterioration in the U.S. consumer,” said Adam Farstrup, head of multi-asset, Americas at Schroders, adding “we haven’t seen it yet.”
EXPECTATIONS FOR CORPORATE EARNINGS FALL SHORT
Rising expectations for corporate earnings could make it harder for companies to beat forecasts. Third-quarter reports kick off in the next few weeks, and S&P 500 companies overall are expected to increase earnings by 8.6% from the year-ago period, up from an expected 8% rise as of July 1, according to LSEG IBES.
“The bar has been raised a bit higher this time around, and so I’m a little concerned that if companies fail to meet more buoyant expectations, you could see a little bit of an adjustment in prices,” said Michael Arone, chief investment strategist for State Street Investment Management.
Fallout from tariffs could weigh on results, investors said.
“If you see more companies saying demand is coming down or margins might come down because of trade or tariffs… that could be a little bit of a negative for the stock market,” Saglimbene said.
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.
“The valuations are very demanding,” said David Bianco, Americas chief investment officer at DWS. “I do think there will be volatility along the way.”
High valuations in megacap technology and growth stocks that are heavyweights in indexes present a particular risk, including if doubts emerge about the AI investment and spending.
“We haven’t seen any evidence of cracks at all, but obviously that’s something that if it were to occur, I would suspect the market would react negatively to that,” Bond said.
(Reporting by Lewis Krauskopf; editing by Megan Davies and David Gregorio)
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