Investing.com -- The S&P 500 continues its upward momentum, supported by investor optimism and muted reactions to potential risks, UBS analysts said in a note Monday morning.
However, the investment bank cautioned that the rally could set the stage for a correction in early 2025 if data or policies deviate from expectations.
UBS highlights that "with risks either not materializing or investors not paying much attention to them as the holidays approach, the path of least resistance is for markets to keep rallying."
They note that events such as in-line inflation data this week and a likely 25-basis-point rate cut by the Fed next week are already priced into the market.
However, "upward momentum tends to be self-reinforcing," potentially leading investors to overextend.
This rally coincides with a backdrop of political and economic resilience.
UBS notes, "US financial market performance the past few weeks is also noteworthy in that it suggests investors are less worried about inflation risk then they were right after the 'red sweep' election outcome."
Treasury yields have fallen, while equities, particularly growth stocks, have risen. Yet, UBS believes this optimism may overlook potential pitfalls, including unforeseen inflationary surprises or adverse policy developments under the new administration.
The risk lies in complacency, UBS warns. For instance, the prioritization of policies by the Trump administration could weigh negatively on growth or inflation.
Additionally, inflation surprises could challenge market assumptions. UBS states, "The trade-off is that it sets up the markets for a correction in 1Q should the data or policy fall short of expectations."
The bank concludes: "Even if the policy path appears benign, inflation on its own could surprise to the upside. All this looks like a problem for next year, when investors should take seriously the question of "what risks?"