Why is the stock market dropping at the beginning of Jan 2025?

 You’ve probably noticed that the stock market has been dropping over the past few days. Why is this happening?  There may be several factors:

◦ Bond yields are rising.  Why?  Due to the latest jobs report, investors now anticipate that the Fed may not cut rates for the rest of the year. In fact, some think there is an outside chance that the Fed will raise interest rates this year if inflation heats up again.  If bond investors think Fed rates will rise in the future, then they get motivated to sell their bonds to get ahead of that move.  The elevated selling causes bond prices to drop since this increases the supply of bonds on the market.  Lower bond prices means the bond “yield” increases.  Higher bond yield then encourages stock investors to sell stock and purchase bonds.  This is because bonds represent a “risk free” investment.  Stocks may appear more expensive to investors, for example, as the risk-free return that investors can obtain by holding U.S. government debt increases.
◦ There are fears that Trump’s policies on tariffs, tax cuts, and mass deportations could cause inflation to rise
◦ When bond yields rise, this causes borrowing rates (such as mortgages, auto loans, and credit card interest) to rise.  Higher borrowing costs can slow the economy.
◦ Higher interest rates also negatively affect corporate profits.  Lower profits lead to a higher P/E ratio.  This stretches stock valuation, basically making stocks more expensive.
◦ The stock market has had an incredible run over the last 2 years.  The P/E ratio of many stocks is higher than their historical average.  This makes the stock more expensive, which then increases the “risk”.  Remember, there are no assets that are so good that they can’t become overpriced and dangerous
◦ There is still the lingering budget deficit/national debt issue

What does this mean for 2025?
◦ I think we should proceed cautiously this year until we get more clarity on all of the above items.

How will the market perform over the next few years?
◦ It is difficult to predict with all of the unknowns noted above.  
◦ There are some that think the market has run so hot that it could result in single digit growth in the S&P 500 for the next couple of years.
◦ There are others that think the AI boom is still in its infancy