Investing.com — Investors may be underestimating risks heading into 2025, describing the current sentiment as “too complacent,” BCA Research said in a Monday report.
The investment research firm highlights that while financial markets are discounting only a negligible probability of recession, this overconfidence could lead to significant disappointments, even without an economic downturn.
“History is arrayed against the bulls from a macro and market valuation perspective,” the report states.
Equity markets are particularly vulnerable, with the S&P 500 trading at nearly 23 times forward earnings—levels nearly two standard deviations above its historical average. Tight corporate bond spreads further amplify the risks, as both investment-grade and high-yield spreads are trading near their historical lows.
“Although we believe a 2025 recession is more likely than not, risk assets could disappoint even in the absence of a recession, and current prices do not augur well for future returns,” BCA cautions.
BCA points out several key themes in the current environment. It emphasizes that consumer trends are shifting as tailwinds from buoyed household spending that emerged during the pandemic are now fading.
“Revenge spending appears to have run its course, and a widening range of retailers report that consumption momentum has faded,” BCA strategists note. Financial pressures are now spreading to middle-income households, a concerning sign that economic strain is moving beyond lower-income brackets.
Meanwhile, the labor market, while not in crisis, is showing subtle signs of weakening. Metrics from the Job Openings and Labor Turnover Survey (JOLTS) reveal slowing hiring activity, with key measures like the quits and hires rates at four-year lows.
BCA says that employers appear to be leveraging return-to-office mandates as a “severance-free way of trimming payrolls.”
In this environment, BCA advocates a defensive approach, recommending underweighting equities.
“Our bar for underweighting risk assets is much higher than our bar for overweighting them, but the softening macro backdrop and demanding valuations clear it now,” the firm explains.
“We will be eager to narrow the underweight soon after the 20% bear-market threshold is reached and will likely look to overweight equities around -30% to -35%, if they fall that much,” it added.
BCA acknowledges the possibility of a near-term rally in stocks extending through year-end and into January. However, the firm anticipates an equity bear market to develop during the first half of 2025 and plans to reassess opportunities to position against equities if current defensive stops are activated.
