Despite ongoing geopolitical turbulence, markets are closing the year on an upbeat note. For the first time since the 1990s, the S&P 500 index has posted a second consecutive annual gain of more than 20%.
Against this backdrop, it might seem that 2025 will bring a cooling period; after all, markets cannot grow indefinitely, especially when driven by a handful of stocks, even if they are tech giants.
Still, most expect indices to continue climbing. While double-digit growth isn’t in the cards for baseline forecasts, it’s notable that no one amongst the top banks is predicting a market downturn.
Of course, that doesn’t mean 2025 will be entirely smooth sailing. Unexpected events can always disrupt confidence and cause markets to deteriorate sharply.
Some speculate that the current administration keeps the markets afloat until the next president takes office. But since this theory leans more toward conspiracy than fact, let's set it aside.
Focusing instead on tangible risks that could have a real impact, the first to stand out, and perhaps the most immediate, is the looming threat of another default on U.S. government debt.
According to Janet Yellen, the US debt ceiling will be reached in mid-January. If Congress does not reach an agreement by then, the government could run out of funds, approaching the first default in its history.
In 2011, delays in raising the debt ceiling led credit rating agency S&P to downgrade U.S. debt on August 5. Just days later, on August 8, the S&P 500 plunged nearly 7%, an event now remembered as Black Monday.
Another risk is that the Fed will keep interest rates higher for longer. Under these conditions, refinancing debt incurred during the pandemic could make it more difficult for companies to meet their obligations.
This could lead to an increased risk of defaults, which would negatively impact markets. Although it has not yet been a major problem, as some feared, it could eventually trigger a domino effect.
Another aspect to consider is the public debt bubble. Net interest payments exceed $870 billion, more than the $822 billion spent on defense, and are expected to rise further over the next decade.
This is not primarily due to the Fed keeping high interest rates, but to the fact that the appetite for debt remains strong, and despite promises of significant spending cuts, there is no budget surplus in sight.
The problem is unclear who will buy all the new debt. Foreign holdings of U.S. Treasuries have been declining, so the country may be forced to offer higher yields to attract capital.
In the long run, the situation does not look very sustainable.
What is the bottom line? Investing is not only about making profits but also about protecting the capital. Diversify your portfolio and be prepared for a market downturn, even if it seems unlikely now.