Jacob Sonenshine

The S&P 500 has risen 14% to 5680 in less than a month from an early April low of 4982, the nadir of its nasty decline. It's poised to make a run at a record high.

In early April, the market became confident the Federal Reserve could cut interest rates to stabilize growth if tariffs slow the economy down enough. Tariffs are inflationary, but weaker consumer demand could ultimately offset that, keeping a lid on inflation -- allowing the Fed to cut.

Then President Donald Trump announced a pause on some tariffs, and has signaled willingness to negotiate with countries. It's now possible the full extent of the larger-than-expected tariffs Trump announced weeks ago after the market closed on April 2 -- "Liberation Day" -- won't happen. That's been a relief, as stocks dove in the days after the announcement.

The best news is that the economy has held up well. April's employment report showed better-than-expected job gains, indicating that corporate concern about demand hasn't translated yet to laying off tons of people. But the jobs report wasn't so strong that it undermines the Fed's ability to eventually cut rates.

Now, the S&P 500 has topped its pre-Liberation Day level, 5670, set on April 2. That the market has clawed back all its losses since then shows investors are now far less concerned about the economic impact from tariffs than initially. If the index breaks just a bit more above that level, the act would signal more gains in the near term are likely. It would reveal more buyers are coming in at around 5670, whereas the last time it was sellers who took control near that level.

Momentum could take hold. From 5680, the only needs to gain 8% to reach the record close of 6144, set in late February. That may sound like a difficult goal, but rallies of that size have happened in a matter of weeks several times in the past year.

Presently, "U.S. large caps believe the American economy is largely immune from recession and markets are simply recovering from a very short bout of crisis-level volatility," wrote DataTrek's Nicholas Colas in a report. "This bodes well for the rest of Q2 2025, which should see the signing of a few U.S. trade deals as well as a Fed rate cut. April's lesson is that it takes a genuine shock to kill equity-investor sentiment."

To that point, asset prices in public markets often swing too drastically in either direction -- including upward. The market is simply in rally mode right now.

That's why it's important to remember that a rally to a new high would bring the market back to a level that's too expensive, given remaining risks to the economy and corporate profits. Assuming analyst's estimates for aggregate S&P 500 companies' earnings per share for the coming 12 months remain at the current $275, a record high implies that the index would trade at 22.3 times. That's close to the highest multiple in the last three years, according to FactSet.

What's worse, the multiple would look even higher if earnings estimates drop, making the market look easily too expensive. Earnings for the first quarter have largely come in higher-than-expected as there hasn't been quite enough time for the demand impact from tariffs to set in yet. But the potential for analysts to reduce their earnings forecasts -- more than they already have -- lurks in the back of investors' minds.

Analysts have lowered this year's earnings estimates for S&P 500 companies by just over 3% since the start of the year. However, profit projections drop 10% over the course of an average year dating back decades, according to Evercore. This isn't an average year, though, and it could see more damage to the economy than anything else. Lower earnings expectations may be on the way, pressuring stocks later in 2025, especially if they're now about to race up to new highs.

High valuations reflect investors' expectations for larger earnings, so if firms post only slightly better-than-expected earnings, stocks could fall. If earnings flat-out disappoint, stocks would certainly tumble.

"The rally off the early April lows has taken the S&P 500 back to levels that demand predictable economic/earnings growth, and high levels of investor confidence that this environment will persist," Colas writes.

In the end, investors shouldn't be surprised to see the S&P 500 setting highs again, but they shouldn't think it's time to buy.

Write to Jacob Sonenshine at jacob.sonenshine@barrons.com

This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.

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May 02, 2025 13:49 ET (17:49 GMT)

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