The stock rally is back on track. Memories of 2022 linger.

Investors have to gauge whether corporate earnings can perpetuate the stock rally. Photo: David Dee Delgado/Getty Images
Investors have to gauge whether corporate earnings can perpetuate the stock rally. Photo: David Dee Delgado/Getty Images

Summary

Investors worry the hefty tariffs and mass deportations that Trump has proposed will reaccelerate inflation.

Investors have to gauge whether corporate earnings can perpetuate the stock rally.

Stocks got their groove back in the days ahead of Donald Trump’s presidential inauguration, but some investors are worried that the shadow of 2022 will loom over markets this year.

The S&P 500 index and Dow Jones Industrial Average logged their best week since early November after Wednesday’s consumer inflation report suggested underlying price pressures were easing. Investors, who were largely positioned for a disappointing report, rekindled the faltering stock rally. The yield on the benchmark 10-year Treasury note pulled back and ended the week at 4.61%.

The rally put stocks back in the green for 2025, but some analysts and investors worry the reprieve will be brief. With Trump returning to the Oval Office on Monday, they worry that the hefty tariffs and mass deportations he has proposed will reaccelerate inflation.

Graphic: WSJ
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Graphic: WSJ

“The threat of higher inflation just lives so large in our head that it’s easy to go to a spot where we imagine 2022 happening all over again," said Callie Cox, chief market strategist at Ritholtz Wealth Management. “That wound of inflation is still fresh."

Stocks and bonds fell in tandem in 2022 after the Federal Reserve began aggressively raising interest rates to tame wayward inflation. The bruising losses left traders with nowhere to hide, until the frenzy over artificial intelligence pushed stocks into a bull market the following year.

Investors are on edge that Trump’s proposed agenda and other government policies could set off another leg higher for bond yields and, in turn, send stocks reeling again. Surging yields kept a lid on stock returns for much of the past month. Stocks started tumbling in mid-December when the Fed signaled a more cautious approach to cutting interest rates going forward.

Investors are also concerned about growing government deficits from any tax cuts. Larger deficits mean the Treasury Department will need to issue more debt, and additional supply can diminish the value of existing bonds. Bond prices rise when yields fall.

Investors will parse a robust slate of earnings this week from the likes of Netflix, Procter & Gamble and American Express as they try to gauge whether corporate earnings can keep the stock rally going.

Exuberance among individual investors has cooled as of late. Bullish sentiment, measured as the expectation that stocks will rise over the next six months, fell to its lowest level since November 2023, according to the latest American Association of Individual Investors survey.

We expect “a lot more index-level volatility driven more by policy coming out of Washington," said Kevin Gordon, senior investment strategist at Charles Schwab. “That’s clearly going to be the differentiator for 2025 than it was in 2024."

Graphic: WSJ
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Graphic: WSJ

Among other potentially worrisome signs, shares of the tech titans have tumbled in recent weeks, weakening a pillar of the gangbusters rally of the past two years. The Magnificent Seven—Alphabet, Amazon.com, Apple, Meta Platforms, Microsoft, Nvidia and Tesla—have shed about $620 billion collectively in market value over the past month.

Stocks could be sensitive to rising yields now because they were already looking expensive by historical standards. The S&P 500 was recently trading at 22 times its expected earnings over the next 12 months, above its 10-year average of 18.5 times.

Some investors also worry that a rise in benchmark yields, which set the borrowing costs for things such as homes and student loans, could put more pressure on cash-strapped Americans and test the economy’s resilience.

To be sure, recent data show the economy remains on solid footing. That bodes well for stocks longer term, even if that strength is accompanied by a jump in yields, some investors say.

“There’s been scenarios plenty of times in the past where rising rates are not bad for stocks," said Shana Sissel, chief executive at Banrion Capital Management. “If the economy can do fine in a higher rate environment, then why would we think that’s not going to be good for stocks?"

A blockbuster jobs report for December revealed that hiring activity raced past expectations, indicating that the labor market is still strong and might even be gaining steam.

On the earnings front, JPMorgan Chase reported a 50% surge in net income for its most recent quarter, while profit at Goldman Sachs more than doubled. Executives reported that big corporate clients are ravenous for capital to fuel big-ticket investments.

Companies have already kicked off the year with a fresh wave of deals. JCPenney said it has merged with Sparc Group, which owns such brands as Brooks Brothers and Eddie Bauer. Getty Images Holdings and Shutterstock are combining to form a $3.7 billion company. Constellation Energy agreed to buy power company Calpine for $16.4 billion.

“We no longer need the Fed to be aggressive in cutting rates. That feels [like] Goldilocks," said Mark Hackett, chief market strategist at Nationwide.

Write to Krystal Hur at krystal.hur@wsj.com

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