By Jacob Sonenshine

The stock market rally is winding down as cracks in its momentum begin to show. Caution is the best course of action.

The market should have had a good week. On Thursday, President Donald Trump agreed to a trade deal with the United Kingdom, while Treasury Secretary Scott Bessent was set to meet with Chinese officials on Saturday to discuss tariffs. What's more, the Federal Reserve, while keeping interest rates unchanged this week, did nothing to suggest that it won't be able to cut rates later this year, if it so chooses. The combination should have provided a boost of optimism for stocks.

Instead, the market reaction was underwhelming. The Dow Jones Industrial Average was down 0.3% for the week, while the S&P 500 and the Nasdaq Composite were falling 0.5%. More concerning, the S&P 500, at 5660, stalled at resistance near 5700 after having gained 14% from the 4982 low point of its April swoon. The lack of a response suggests that much of the good news is already reflected in the stock market.

"I don't think this is a great time to put new money to work," says Wells Fargo strategist Chris Harvey.

Good news is certainly reflected in the S&P 500's valuation. The index trades at 20.6 times based on analyst estimates for earnings over the next 12 months, near the higher end of its three-year range and in the 86th percentile historically, according to Citigroup data. While valuation isn't a timing tool, high multiples usually precede lower returns for the index. The high valuations also reflect the market's confidence in analysts' S&P 500 earnings estimates of $264 in 2025.

That confidence could be tested in the months ahead. Investors want trade deals, but the state of negotiations remains fragile. Trump is known for contradictory policy announcements, and even the success of negotiations with the U.K. -- which had a trade deficit with the U.S. -- might not serve as a model for deals still to come. And while the fact that the U.S. and China are set to talk is good news, the outcome is far from determined.

"We know there is a meeting (the known), we just don't know what will come of it (the unknown)," writes Jonathan Krinsky, chief market technician at BTIG, who warns of "a very poor near-term risk/reward" for stocks.

Investors shouldn't expect the Fed to come to the rescue either. During his Wednesday press conference, Chair Jerome Powell was unwilling to commit to cuts to ward off a potential tariff hit to the economy. The reason: The levies, even if rolled back a touch, could boost inflation and even set the economy up for stagflation -- a scenario in which prices rise but the economy stalls. It's the Fed's worst nightmare -- and one investors need to take seriously.

Evercore ISI strategist Julian Emanuel notes that over the past seven years, the chart of the consumer price index has looked eerily similar to the way it looked in the mid to late '70s. "Powell, mindful that tariff-driven inflation opens the door to the mid-1970s...will remain noncommittal about the next cut," Emanuel writes.

And that means the best course of action is to remain noncommittal to the stock market as well.

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

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May 09, 2025 12:18 ET (16:18 GMT)

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