Michelle ThompsonSince the pandemic, millions of Americans have seen their net worth rise sharply, driven by a booming stock market. Wall Street’s back-to-back record-setting years, reminiscent of the late 1990s, have bolstered consumer confidence and spending.
However, concerns are mounting that some stock prices have become disconnected from reality. Experts fear this could lead to a painful market downturn with broader economic consequences.
Mark Zandi, chief economist at Moody’s Analytics, expressed alarm, stating, “The market is richly valued, bordering on frothy.” He noted that stock valuations appear unsustainably high, with investors assuming perpetual growth.
The Nasdaq, fueled by the AI boom and tech giants known as the “Magnificent Seven,” climbed 29% last year, following a 43% surge in 2023. The S&P 500 added $10 trillion in value in 2024 alone. While markets have recently dipped, Zandi warns of a potential decline exceeding 20%, reminiscent of the late 1990s dot-com bubble. Although he does not anticipate a collapse of the same magnitude, he cautions that a significant drop could harm the economy.
A stock market downturn would erode consumer confidence and spending power, particularly among high-income households. Since consumer spending drives the U.S. economy, any sustained market decline could have serious ripple effects.
“The wealth generated by rising stock values has been a key driver of economic success,” Zandi explained. “If the market fell and stayed down, it could severely impact spending, posing a real threat to economic stability.”
“Not grounded in reality.”
Economists suggest that the economic outlook for 2025 appears solid, with low layoffs, reduced inflation, rising wages, and stable gas prices.
However, David Kelly, chief global strategist at JPMorgan Asset Management, expressed concern over high valuations, warning that they leave financial markets susceptible to a sharp decline.
“I’m worried about asset bubbles,” Kelly told CNN. “Many unrealistic expectations have been built upon the foundation of this stable economy.”
Timing the market is notoriously challenging, and history demonstrates that overvalued stocks can remain inflated—or even rise further—for extended periods.
Kelly specifically highlighted the high valuations in large-cap U.S. stocks and assets like bitcoin. He warned, “You could see a significant correction in assets not grounded in reality.” He pointed out that many markets are currently “frothy” and could face steep declines, urging investors to carefully consider the risks they’re taking.
However, as is often the case, timing the market is difficult. Overvalued stocks can remain inflated—or even continue to rise—for a while. For example, in the late 1990s, some internet companies that weren’t generating revenue still saw their stock prices soar until the market eventually corrected around 2000.
Attempting to bet against the market has also been costly. Despite the worst inflation in four decades and the most aggressive Federal Reserve since Paul Volcker’s era, the bull market has continued.
Bubble warning from UBS
Recent cracks have begun to show in the market, leading investors to closely examine the heavy reliance on the “Magnificent Seven” tech stocks: Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, and Tesla. Over the past two years, the S&P 500 posted an impressive 58% return, but that figure would have dropped to just 24% without the contributions from these seven companies, according to S&P Dow Jones Indices.
US stocks ended 2024 on a weak note, and the volatility continued into 2025. UBS recently warned its clients that nearly all of the seven key conditions for a market bubble are already in place.
“The issue with a bubble is that when it bursts, investors typically lose 80% of their money,” said Andrew Garthwaite, UBS global equity strategist, in a December 18 report. He pointed to historical examples of bursting bubbles, including the Nifty 50 in the 1970s, Japan’s market in the late 1980s, and the dot-com bubble.
UBS identified several preconditions for a bubble, such as a 25-year gap from the last bubble, retail investor participation, and profit pressures. A bubble forms, Garthwaite explained, when there’s a prevailing narrative of “it’s different this time,” often associated with technology or market dominance—and we have both today.
The good news, according to UBS, is that the market isn’t in a bubble yet, and stocks could still rally another 15% to 20% before clearly entering bubble territory. Nevertheless, it’s notable that major Wall Street banks are even using the term “bubble” in their analysis.
The bond market is feeling unsettled.
Whether or not the market is in a bubble, there are numerous potential triggers that could lead to a downturn, especially given the lofty expectations in place.
One risk is that a stumble by one of the high-flying stocks driving the current rally could cause a ripple effect, dragging down others in the group. The bar for these companies has been set incredibly high.
Additionally, lawmakers in Washington will eventually need to address the looming issue of the debt ceiling, which was reinstated on Thursday, adding further uncertainty to the economic landscape.
Traders on Wall Street are still trying to understand the economic agenda of the incoming Trump administration.
Investors are still trying to interpret the economic agenda of the incoming Trump administration, which includes tax cuts, tariff increases, deregulation, and mass deportations.
A tariff announcement or significant immigration crackdown could easily unsettle investors, particularly those concerned about inflation. However, early signs of trouble may first show up in the bond market.
Ed Yardeni, president of Yardeni Research, warns that the stock market could be rattled if a bond market selloff pushes the 10-year Treasury yield toward 5%. Yardeni, who coined the term “bond market vigilantes” in the early 1980s, explained that investors will be closely monitoring whether Republicans in Congress can address rising concerns over federal budget deficits.
“If they can’t get their act together and only agree to tax cuts, the bond market will freak out,” he said.
“Not a cause for alarm.”
Given the scale of recent gains, it’s natural for some investors to consider the possibility of a market reversal.
However, it’s also possible that the market won’t decline, but instead, move sideways. This would allow corporate profits to catch up with high valuations.
Yardeni doesn’t foresee a high risk of a bear market—a 20% drop from recent highs—since a recession doesn’t seem imminent. However, he predicts a 10% to 15% correction.
“I would see it as a buying opportunity, not a reason to panic. That doesn’t mean it won’t be uncomfortable,” Yardeni said.
Kristina Hooper, chief global market strategist at Invesco, added that long-term investors should look past any short-term market dips. She believes the overall environment remains positive for stocks and risk assets.
“It’s irrelevant in the grand scheme of things,” Hooper said. “We could see a pullback, but I think it would be temporary and possibly healthy, setting the stage for the next market rally.”
Emily Martinez
