- The stock market is pricing in a handful things that might not pan out, according to Deutsche Bank.
- The bank highlighted three of the “most obvious” dislocations in US markets.
- Rate cuts, Trump’s tariffs, and stock valuations are things investors might need to correct their views on.
Investors may be mispricing a handful of things that are being factored into market outlooks in 2025, according to Deutsche Bank.
In a note to clients on Tuesday, the bank pointed to three of the most prominent dislocations in the US market, with investors assigning potentially incorrect odds of future events with the likelihood to move asset prices.
“Markets often behave inconsistently, with patterns that don’t make obvious sense between asset classes. These dislocations can last for a long time,” Deutsche macro strategist Henry Allen wrote. “This got us thinking about what some of the most obvious dislocations are today, considering what looks odd, and therefore what might be ripe for a correction.”
Here are the top three things investors may need to rethink, according to the bank.
1. Markets might be too optimistic about rate cuts
Investors could be too optimistic about the outlook for the Federal Reserve to cut interest rates this year.
Traders are pricing in a 31% chance the Fed will cut rates 50 basis points by the end of 2025, according to the CME FedWatch tool.
Yet, markets are also expecting inflation to remain above the central bank’s target. One-year and two-year inflation expectations are hovering around 2.7%, Deutsche Bank noted, still above the Fed’s 2% target.
Bloomberg Finance LP, Deutsche Bank
Consumer price increases have also accelerated in recent months. Trailing three-month inflation rose to 3.9% year-over-year in December, the fastest three-month inflation reading in around eight months, Allen highlighted.
“Given the recent record of above-target inflations since 2021, it seems hard to imagine that the Fed would want to take risks in easing too aggressively,” Allen added.
2. Markets may be underpricing Trump’s tariff plan
Traders don’t seem to be expecting Trump to aggressively levy tariffs during his second term, despite his promises to do so on the campaign trail.
80% of global market participants said they thought Trump’s tariff plan would be less aggressive than what he suggested during his campaign, according to a survey Deutsche Bank conducted last month.
While Trump’s day-one order on the issue was fairly benign, the threat of a disruptive trade war still looms over markets.
Based on inflation expectations, investors only seem to be pricing in a 5% universal tariff and a 20% tariff on US imports from China, Deutsche estimated. The estimates reflect a weaker tariff plan than what Trump floated on the campaign trail, which included a 10%-20% universal tariff and a 60% tariff on goods from China.
“In summary, markets are pretty exposed, even if Trump only follows through on his stated tariff threats,” Allen added. “This is clearly something markets aren’t accounting for right now.”
3. Valuations may need to be reined in
Investors might be getting too comfortable with sky-high stock valuations.
The CAPE ratio of the S&P 500, or the cyclically adjusted price-to-earnings ratio, is hovering around levels that mirror the 2021 market peak and the years leading up to the bursting of the dot-com bubble, Allen said.
Haver Analytics, Deutsche Bank
Yet, economic growth is weaker than it was in those time frames. Growth in the fourth quarter of 2021 and in the late 90s hovered around 4%, but GDP growth in the fourth quarter of 2024 is estimated to clock in at about 3%, according to the Atlanta Fed’s latest GDPNow reading.
“US equity valuations have never been this high with growth this weak,” Allen added.
Investors have been on high alert in recent months for a potential correction, with some strategists calling for as much as a 16% drop in the market. Wall Street, though, remains generally bullish on stocks in the coming year, with tax cuts, deregulation, and easier monetary policy set to boost the market.
