What the stock market's post-Fed-meeting optimism may be getting wrong about the U.S. economy

By Christine Idzelis

'The market just isn't believing what the Fed is projecting,' says Unlimited Funds investment chief Bob Elliott

Both the Dow and the S&P 500 booked record highs on Thursday.

The U.S. stock market, trading at fresh record highs despite economic challenges, may be expecting more easing from the Federal Reserve than it's going to get next year.

"It's a fragile economy priced to perfection," cautioned Bob Elliott, co-founder, chief executive officer and chief investment officer at Unlimited Funds, in a phone interview. The market seems to expect a "run-it-hot set of policies" from the Fed, he said, partly in anticipation that the next chair selected by President Donald Trump to replace Jerome Powell in 2026 will be more inclined to lower interest rates.

Socks climbed after the Fed on Wednesday decided to cut its benchmark rate and released a Summary of Economic Projections on U.S. growth, inflation and the potential path of rates. Projections for 2026 included gross domestic product in the U.S. being revised higher, inflation revised lower and the Fed likely to cut its policy rate again - a "Goldilocks" backdrop for equities, according to a note Thursday from Renaissance Macro Research.

Yet the labor market, at the core of the economy, is weak, while wage growth is "softening," worried Elliott. "The big challenge" is that, despite a "great year" for stock prices, rate cuts by the Fed and "a lot of hope" in the markets that the One Big Beautiful Bill Act will support the economy, the labor market and wage growth don't seem to be improving, he said.

The U.S. stock market closed mostly higher Thursday, with the Dow Jones Industrial Average DJIA climbing sharply to end at a record high. The S&P 500 SPX finished modestly higher to join the Dow in booking a fresh all-time high even as its technology sector fell, while the tech-heavy Nasdaq Composite COMP retreated 0.3%, according to Dow Jones Market Data.

The widely followed S&P 500 index has advanced 17.3% so far this year, with its tech sector XX:SP500.45 up 26.1% through Thursday. The Dow outperformed on Thursday as large-cap value stocks RLV beat growth equities. But the blue-chip gauge is lagging in 2025 with a 14.5% gain, with value stocks trailing growth RLG so far this year, according to FactSet data.

The Fed's Summary of Economic Projections released on Wednesday showed a median forecast for the U.S. economy to expand 2.3% next year, measured by real GDP, up from the 1.8% projected in September. The 2026 forecast for the U.S. unemployment rate remains unchanged at 4.4%.

"I am skeptical of the Fed's unemployment outlook," said Neil Dutta, head of economic research at RenMac, in the firm's note Thursday. Real GDP has been at least that strong over the past 21/2 years, Dutta said, and the unemployment rate has still climbed by one percentage point over that period.

'Either the core of the economy has to accelerate and confirm the high expectations of growth, or stocks are going to come down.'Bob Elliott, Unlimited Funds

"The Fed sees itself within the 'broad range' of neutral" with respect to its policy rate, which implies it's no longer perceiving its posture as "restrictive," according to Dutta. With differing views on the Federal Open Market Committee as to the future path of rates, "additional cuts will require clear evidence that policy needs to shift," he said. "Don't expect the Fed to step in to backstop labor-market conditions until after they've already cracked."

A deteriorating labor market wouldn't bode well for stocks.

"Either the core of the economy has to accelerate and confirm the high expectations of growth, or stocks are going to come down," said Elliott.

Part of what drove the stock market's rise Wednesday after the conclusion of Fed's two-day policy meeting was its decision to purchase shorter-term Treasury securities to ensure there are sufficient bank reserves, according to Elliott.

"But I think a lot of folks are extrapolating" that the Fed is going to start quantitative easing in 2026, he said. That, he added, seems like "a bit of a leap."

The stock market is also pricing in more rate cuts than just the one that the median Fed official penciled in for next year in the Summary of Economic Projections, according to Elliott.

Federal-funds futures showed Thursday that traders expect that the FOMC may reduce rates twice next year, including one by June, according to the CME FedWatch Tool, at last check. "The market just isn't believing what the Fed is projecting," said Elliott.

The stock market seems optimistic that productivity has increased in the U.S. economy, even if it is hard to tell how much of that is linked to artificial intelligence or has arisen from a move toward automation and computers replacing labor during the pandemic, according to David Kelly, chief global strategist at J.P. Morgan Asset Management.

But Kelly thinks "next year is going to be a year of two halves," he said by phone, with the first half potentially "pretty strong." That's partly because income-tax refunds are expected to be larger next year, boosting consumer spending, he said. Then, he said, "unless we see some further fiscal stimulus, I think the second half is going to be pretty slow."

On Wednesday, the Fed's decision day, investors pulled $8.7 billion from equity exchange-traded funds listed in the U.S., according to a report Thursday from CreditSights. Still, inflows into U.S. equity ETFs rose 23% in the week through Wednesday to $11.3 billion, the report shows.

"We believe the macro backdrop is still very optimistic," even if it's "unstable" due to lingering worries about Trump's tariff approach, a so-called K-shaped economy in which lower-income people are under financial pressure even as the wealthier are doing fine, and "shifting labor dynamics," said Jodi Love, a portfolio manager for actively managed equity ETFs at T. Rowe Price, in an interview.

"I do think we'll continue to see a lot more volatility," Love said. "If growth and earnings hold up," she said, "I believe equities can live with a slower" rate-cutting path from the Fed.

-Christine Idzelis

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