The Stock Market is Off to a Strong Start in 2025. Keep an Eye Out for These Potential Pitfalls

Investors kicked off 2025 with cautious optimism after a strong 2024 performance, despite challenges in the latter part of the year. The focus now shifts to critical U.S. labor market updates, particularly the December jobs report due Friday. Investors are also closely watching the potential policy shifts under President-elect Donald Trump, who will take office on January 20.

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The stock market faced headwinds at the close of 2024, with inflationary pressures and Federal Reserve signals suggesting only two interest rate cuts in 2025. While these factors have tempered market enthusiasm, Michael Green, portfolio manager and chief strategist at Simplify Asset Management, warns against assuming stability in the labor market. Green points to discrepancies between nonfarm payroll data and alternative indicators, such as the Institute for Supply Management’s (ISM) manufacturing index.

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For December, the ISM manufacturing index rose to 49.3, indicating a slower contraction, but its employment gauge dropped to 45.3, signaling significant job losses. Meanwhile, the ISM services index showed continued job growth in November, albeit at a slower pace, with an updated report due this week. These mixed signals highlight the complexities in interpreting labor market trends.

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Green also raised concerns about the gig economy's impact on jobless claims data. Workers who lose traditional jobs may turn to gig work, such as driving for Uber, instead of filing for unemployment benefits. This shift may explain why initial jobless claims remain low even as continuing claims rise. Additionally, the number of full-time private-sector jobs has reached recessionary levels, while state and local government jobs, which are more vulnerable to economic fluctuations, have grown.

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Green is particularly critical of the U.S. Bureau of Labor Statistics’ birth-death model, which estimates net job creation by accounting for new businesses and closures. He argues that this model is ineffective during economic turning points and expects significant downward revisions to job data early in the year. Such revisions could have broad implications, as nonfarm payroll figures influence other key economic metrics, including personal income and GDP.

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Given these uncertainties, Green believes the December jobs report may offer little clarity for investors.

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Despite these labor market concerns, U.S. stocks have started 2025 on a positive note. The S&P 500 gained 1% over the first two trading days, while the Nasdaq Composite rose 1.6%, marking the best start to a year for both indexes since 2018. The Dow Jones Industrial Average posted a modest 0.4% gain. However, the market still recorded losses for the week, shortened by the New Year’s Day holiday on Wednesday. Another shortened week is ahead, with markets set to close Thursday in observance of a national day of mourning for former President Jimmy Carter.

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Mark Hackett, chief market strategist at Nationwide, noted the mixed emotions among investors. While there is optimism for the medium to long term, near-term uncertainties and weaker technical indicators have created some nervousness. Hackett views the current period of consolidation as a natural and healthy response following two years of impressive gains, with the S&P 500 advancing 23.3% in 2024 and 24% in 2023.

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Political developments could also shape market sentiment. Rep. Mike Johnson of Louisiana was re-elected as House Speaker, avoiding a potentially market-disruptive leadership battle. Analysts suggested that a prolonged fight for the gavel could have eroded confidence in the Republican-controlled Congress’s ability to deliver on promises of deregulation, tax cuts, and other market-friendly policies.

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However, the incoming administration’s plans carry their own uncertainties. Concerns over the growing federal budget deficit have been exacerbated by doubts about whether Trump’s proposed tax cuts will be offset by spending reductions. Additionally, Trump’s plans to impose tariffs on various imports have fueled fears of rising inflation. These factors have contributed to a rise in Treasury yields, reflecting investor skepticism.

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Larry Adam, chief investment officer at Raymond James, emphasized that market volatility is likely to increase in 2025 due to uncertainties around Trump’s policy initiatives, including taxes and tariffs. With equity markets already priced for perfection, there is little margin for economic or earnings disappointments. Further complicating matters, the Federal Reserve’s limited ability to cut rates further may leave it with fewer tools to combat inflation should it surprise to the upside.

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As 2025 unfolds, investors face a landscape characterized by mixed economic signals, political uncertainty, and a volatile labor market. While optimism persists for longer-term growth, near-term challenges demand careful navigation.

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