The job market isn’t making much progress. Inflation is creeping back up. And consumer confidence is dipping to levels we haven’t seen in quite a while. It’s safe to say people are feeling pretty frustrated about the economy.
In contrast, the S&P 500 has recently hit record highs multiple times this month, and the Dow breached 46,000 for the first time. So, what’s with this disconnect? If the economy is struggling, why is the stock market so buoyant?
Oddly enough, stocks might be soaring precisely because of the bleak outlook for the economy.
A notable shift in the job market has led investors to believe the Federal Reserve may have no choice but to lower interest rates several times this year. According to the CME FedWatch tool, investors see an 80% chance of rate cuts in December and an even higher likelihood for October. There’s a 100% expectation that the Fed will announce a cut after their upcoming two-day meeting.
The market is eager for reduced borrowing costs. So far in 2025, the Fed hasn’t made any cuts following reductions that occurred during three meetings late last year. However, Chairman Jerome Powell mentioned that uncertainty due to trade policies could contribute to rising inflation, which could complicate matters.
Wall Street generally welcomes lower interest rates since they reduce loan costs for businesses, enabling greater profits. This, in turn, can enrich stock values, potentially allowing companies to hire more employees. Historically, such cuts usually provide a jolt to the economy over time.
Investors are also encouraged by a developing bond market, as fears of sluggish employment growth have pushed Treasury yields down. The US Treasury market has attracted attention lately, with yields on two-year notes approaching levels not seen since the inflation crisis began in 2022.
Lower bond yields can allow companies to save money on debt, adding value to their stocks.
The S&P 500 has gained 6% since August 1, when a disappointing employment report revealed significant job losses. The market experienced ups and downs during September as it approached the Fed meeting. However, increasing bad news did not deter the S&P 500 from climbing over six of the nine trading days this month.
It seems that, lately, bad economic news has been good for stocks.
Yet, there’s more to the picture.
While the Fed has bolstered optimism about the potential for profit in what is already a historically pricey stock market, strong corporate earnings have also instilled some much-needed confidence.
It’s important to remember that the stock market is essentially a collection of individual businesses. Their prices rise and fall based on how investors perceive their future profitability. If investors didn’t believe in a company’s potential to generate returns, its stock prices wouldn’t soar.
Also fueling the market is the explosive growth in artificial intelligence. In fact, nine of the ten most valuable stocks are heavily invested in AI, collectively making up around 40% of the entire market’s value.
Recently, a certain AI stock skyrocketed by 36% in just one day, largely due to optimistic projections regarding data center demands. This surge has propelled figures like Larry Ellison to incredible wealth, though he seems to have lost some ground to Elon Musk.
Moreover, after the implementation of new tariffs in early August, the stock market has shown some signs of recovery. Certain tax benefits introduced by the government seem to be helping companies stabilize their revenues as well. This has also eased investor concerns about unpredictable governmental policies, allowing for a bit more risk-taking in investment portfolios.
Consumer spending continues to hold strong, despite ongoing worries about tariffs and the economy. Recently released data indicated a 0.5% increase in expenditures for July. This is significant because consumer spending accounts for more than two-thirds of the GDP, serving as a broad measure of economic health.
“It’s not just the Fed,” remarked a Citi research analyst, pointing out that revenue expectations remain optimistic despite fluctuating rates. Together, these factors paint a compelling picture for riskier asset classes.
Still, there remain areas of concern.
Stocks are, historically speaking, quite expensive. The S&P 500 is currently trading at 3.3 times the earnings expectations of its companies — a record high. Plus, there’s a striking price-to-earnings ratio of 25:1, meaning investors are willing to pay $25 for every $1 a company is projected to earn. This could suggest that investor enthusiasm is maybe a bit ahead of reality.
Rising costs could start to stifle consumer spending, ultimately weighing on business revenue growth. With inflation this year costing households an extra $195 per month, per Moody’s chief economist, these pressures are starting to surface.
Meanwhile, consumers have been taking on considerable debt, which presents its own set of problems. Delinquency rates are climbing, especially as student loan payments resume, which is expected to siphon around $80 billion from the economy this year.
While inflation isn’t spiraling out of control like in 2022, there’s growing concern that traditional inflation safeguards are reaching new heights. Gold, for instance, has surged about 40% this year and recently surpassed a record set 45 years ago. Traders worried about inflation often flock to gold as a hedge against rising prices.
Gary Friedman, CEO of RH, has gone on record stating that the inflation situation poses a more significant threat to businesses than many realize.
“What keeps me awake at night? It’s tackling inflation,” he said. “Interest rate cuts and tariffs could actually create more inflation, making it a tightrope walk.”
“It seems like no one is fully grasping the mathematics here,” he added.
