The positive vibe shift in markets is undeniable, but SoFi's head of investment strategy worries this rally is getting ahead of itself

• This year's stunning market rally has gained steam as 2024 comes to a close.
• The positive signals are hard to deny, SoFi's head of investment strategy said.
• Risks loom, but investors can have another strong year by making eight investments.

US stocks are near all-time highs for many reasons, but perhaps the most powerful catalyst right now is an overwhelming sense that the path of least resistance in markets is higher.

That feeling may be intangible, but the S&P 500's recent surge shows it's far from immaterial.

"The scientific way that we said this in the outlook is that 'the vibes are positive,'" quipped Liz Young Thomas, SoFi's head of investment strategy, in a recent interview with Business Insider. "We would expect the sentiment — that positive sentiment — to continue into 2025."

This is the fourth time in the last six years that the S&P 500 has been up at least 20%. While Wall Street didn't think 2024 would be this strong, the mood in markets improved after inflation peaked.

Fittingly, the tagline for SoFi's 2025 market outlook is "defying gravity." In the mid-December report, Young Thomas and her colleagues recommend sticking with this rally instead of fading it.

"Optimism is really pervasive in the market," Young Thomas said. "When, a lot of times, consensus is all in one corner, that's when you want to get skeptical of consensus. But it is difficult to paint a bad picture with the current data."

Reasons for optimism abound

Two years after there was supposedly a 100% chance of a recession in the next 12 months, many almost believe the inverse is the case. Few, if any, mainstream economists see a significant risk of an economic contraction next year, as GDP growth should remain healthy.

"We're no longer debating if this is going to be a hard landing or a soft landing," Young Thomas said. "We're now just debating how soft it's going to be, and whether there's going to be a landing at all."

Other reasons to be bullish include corporate earnings growth in the mid-teens, a solid labor market, plenty of liquidity in markets, lower wage inflation, and rising productivity rates.

There are several possible explanations for why the workforce is becoming more efficient, including the increasing popularity of artificial intelligence. But Young Thomas pointed to another less heralded reason: relatively low labor turnover rates, since hiring and firing rates are down.

"There are not very many people moving around," Young Thomas said. "So then you think about what happens when people don't move around, when they don't leave their jobs: they get better at their jobs. We don't have the downtime of trying to train new employees. So productivity actually goes up, and right now, the measure of productivity is higher than it was pre-pandemic."

It's also impossible to ignore the elephant in the room: Donald Trump.

The business community seems pumped about Trump's presidential win, which Young Thomas said partially — though not completely — explains the market's move higher since late October.

"I think the election gave it more fuel," Young Thomas said. "But if we're looking at the data in a really intellectually honest way, these trends were in place before the election. The market was already momentum-positive before the election."

Mixed signals, red flags still linger

Although markets see growth ahead, Young Thomas noted that they're not necessarily pricing in an economic boom. She studies the relative performance of negatively correlated trades, like how economically sensitive banks fare compared to defensive utilities, and sees mixed signals.

"If everything was just pro-growth, pro-cyclical because of a Republican administration that is expected to be more friendly for businesses, you would expect all of those cyclical indicators to be firing as well — and they're not," Young Thomas said. "So I don't think it's as easy to say it was just the election."

The investment strategy head also cautioned against making simplistic assumptions about what will do well under Trump. After all, traditional energy stocks struggled during his first term, while renewable energy stocks wilted, despite President Joe Biden's support.

"It's not as cut and dry as to just say, 'OK, Republicans are good for this; Democrats are bad for this,' and so on," Young Thomas said.

And while the market thinks it now knows what to expect from Trump based on his first term, Young Thomas isn't so certain. Tax cuts and tariffs are both seen as foregone conclusions, for better or worse, though attempting to map out the implications of either could be dangerous.

"I don't want markets to get to a place where we've decided that it's all going to look exactly the same as it did last time, because it is a different environment," Young Thomas said.

Markets aren't heeding that warning, as investors have scrambled to get exposure to US stocks. That dynamic is pushing stock valuations higher from already lofty levels.

"There's a lot of risk-buying appetite, and that's not necessarily a bad thing in and of itself," Young Thomas said. "But it is a speculative market at a time when things are overvalued largely across the board."

It's unclear how long this market rally can last, and while extended surges aren't unprecedented, they've historically happened before major downturns, like the tech bubble 25 years ago.

"There's a risk that speculation overheats, meaning all that sentiment gets away from us, we get too frothy, everybody gets a little bit too optimistic, and we overbuy all of the assets to the point where it's inflated, and there's not enough fundamental support to keep them up," Young Thomas said. "So that is a risk. The tricky thing about it is that you don't know it's happening until it's happening, until momentum turns."

As for what could cause that optimism to turn, Young Thomas pointed to inflation, which she said could reemerge due to the tariffs that President-elect Trump has pledged. If price growth gets a second wind, the Federal Reserve would likely stop cutting interest rates.

"Obviously, we know that tariffs are being threatened," Young Thomas said. "We don't know for sure how much they will be and how many regions they will be put on, but inflation could reignite, which would turn the Fed in the other direction."

Markets could also get a wake-up call if AI isn't as impactful on productivity and, by extension, earnings as anticipated. Softer demand for semiconductors that power AI functions could cause valuations for high-flying companies like Nvidia to fall back to earth quickly.

8 top places to invest in the new year

In SoFi's outlook, Young Thomas and her peers also outlined eight investments to consider.

Software stocks topped the list, as SoFi sees the group catching up to semiconductors as capital expenditure from businesses ramps up in the next chapter of the AI revolution.

Economically sensitive sectors like energy, financials, industrials, and materials also make sense if the US is in for another year of strong growth. Those first three ideas were also recently highlighted by Sinead Colton Grant, the chief investment officer at BNY Wealth.

"These may not produce the tech-like returns of 2023 and 2024, but a pro-growth environment with looser regulations could make 2025 a friendly cyclical environment," SoFi strategists wrote.

Among defensives, healthcare is worth a shot. Many are worried about the shakeup that Trump allies like Robert F. Kennedy Jr. could give the sector, but the firm believes bad news is already priced in, and earnings should be robust in 2025.

In inexpensive international markets, the only country that stands out is China.

"What I wanted to find was that there would be more opportunities internationally, and then we searched and searched and searched for the data to support it and couldn't find it," Young Thomas said.

Investors are concerned that Trump will play hardball with the People's Republic, but this news may be priced in at this point. Chinese stocks can catch fire if the country issues more stimulus.

Lastly, gold should be a strong hedge if stocks get overheated and speculation dries up. The yellow metal has also performed well in strong markets like this one, as it's near record highs.

"There's a lot of demand for gold from central banks — China, in particular — and the retail investor, I think, will get into gold as things move forward," Young Thomas said.