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Is the U.S. equity market peaking?

February 20, 2025 | 5 min read
Han Peng, CFA
Director, Multi-Asset Research
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Is the U.S. equity market peaking? Following double-digit returns for U.S. equities over the past two years, and with valuations now incredibly expensive, investors have become increasingly concerned about whether the equity market rally still has further to run or if markets have peaked.

Bull markets don’t just die of old age, and history may prove to be a useful guide to identify any catalysts that may signal a potential turn in markets. An analysis of the S&P 500 since 1965 suggests that the Federal Reserve is the most common factor that has triggered the end of sustained equity market rallies.

The culprits of bull market demise

Market returns are influenced by the prevailing economic environment, with the Federal Reserve playing a pivotal role through its monetary policy decisions. Its ability to adjust policy swiftly often has a substantial impact on markets, giving rise to distinct market regimes depending on the Fed’s policy stance.

Markets spooked by aggressive Fed hikes

During the hiking cycles of 1968, 1972, 1980, 1983, 2018, and 2021, the market peaked either at the start or in the middle of the Federal Reserve’s tightening phase. A hawkish pivot from the Fed in response to either economic overheating or spiraling inflation concerns hurt both market sentiment and economic conditions very quickly. This subsequently led to a market drawdown, which was often accompanied by a recession.

When growth slowed but a recession was avoided, the associated market drawdown tended to be smaller (with 2021 as the exception).

The Fed staying restrictive for too long

In instances where the Fed, after embarking on a hiking cycle, kept interest rates elevated for a prolonged period, markets often could sustain their rally—particularly as these periods were associated with strong earnings momentum. However, markets eventually peaked because the Fed left its restrictive policy in place too long. In other words, the Fed likely acted too late in recalibrating its policy stance—as inflation gradually normalized, real rates rose, passively increasing policy restriction and putting downward pressure on growth and earnings.

As seen in both 2000 and 2007, markets continued to rally after the Fed’s pause, peaking about three months after the Fed’s last hike in 2000 and about 16 months after the Fed’s last hike in 2006. Both instances saw economic growth begin to roll over while earnings came under pressure as the Fed clung to its restrictive policy stance.

Although the 2000 and 2007 market corrections were accompanied by a recession, recessions are not necessarily a prerequisite. In 1998, for example, U.S. GDP rose 4.5% on an annual basis despite the economic uncertainty stemming from the Asian financial crisis.

Moreover, while these market peaks were also associated with asset bubbles bursting—namely, the Asian financial crisis, the dot-com bubble, and the global financial crisis— higher rates were one of the catalysts for each of those events.

The black swan event

While it’s easy to put all of the blame on the Fed, other exogenous shocks do occur, which can have a significant impact on markets and are especially difficult to predict.

Throughout history, there have been three noteworthy examples:

  • In 1987, although the market peaked during a Fed hiking cycle, the subsequent downturn was brief and markedly different from the declines in 2000 and 2007. The primary catalyst in 1987 was program trading – an early form of algorithmic trading intended to mitigate losses. Instead, it amplified selling pressure, creating a one-sided market.
  • In 1990, an oil price spike driven by the Gulf War disrupted economic recovery, triggering a mild recession and sending markets lower.
  • In 2019, the emergence of COVID-19 sparked a global health crisis, abruptly interrupting the recovery and causing a sharp, but short-lived recession the following year.

How today’s macro environment compares

With inflation having decelerated from its 2022 highs and the U.S. labor market in better balance, the Fed has paused its rate-cutting cycle, opting for a “wait-and-see” approach to policy.

So far, economic data show little sign of a hard landing. While labor market strength is moderating, overall conditions remain resilient. The services sector continues to hold up well, and industrial activity is finally rebounding. As a result, the economy appears poised for above-trend growth through midyear before gradually returning to trend in the second half of 2025.

Clearly, the current macro environment doesn’t resemble those that characterized previous market peaks. However, despite a seemingly solid economic picture, uncertainty around future policy decisions remains a potential risk.

Inflation remains a key concern, particularly after the January CPI print showed the strongest monthly increase since August 2023, reigniting fears of renewed price pressures. Adding to the uncertainty is the new Trump administration’s fast-moving policy agenda.

Initiatives to enhance government efficiency and tighten immigration could have significant macroeconomic implications, potentially impacting both labor demand and supply.

Meanwhile, with tariffs already announced for Mexico, Canada, and China, and more seemingly on their way, the trade war appears to be escalating. Notably, these tariffs are expected to extend to a broader range of consumer goods than in President Trump’s first term, potentially exerting greater upward pressure on inflation expectations. While the Fed may initially look past tariff-driven inflation, persistent price pressures and the risk of unanchored inflation expectations could prompt a more cautious stance.

Although the bar for a rate hike remains high, a hawkish pivot—driven by rising inflation expectations, stronger economic momentum, continued declines in unemployment, or a reacceleration of inflation—could bring an abrupt end to the current bull market.

Considerations for investors

Bull markets don’t typically die of old age, and history suggests the Fed often plays a key role in shaping market peaks. While investors should remain mindful of rising valuations and the challenges ahead, today’s macroeconomic landscape differs meaningfully from past market peaks, leaving room for continued growth. A narrow but viable path remains for valuations to expand further, especially if earnings growth continues to deliver as expected.

That said, while conditions still support additional upside, navigating the period ahead for risk assets requires caution. Policy uncertainty looms larger than ever and poses a significant challenge to sustain bullish sentiment. Prudent investors should remain vigilant, balancing optimism with a strategic approach to risk in today’s evolving market environment.

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