Investors are expecting more gains for the U.S. stock market in 2025 after two straight standout years, fueled by a solid economy supporting corporate profits, moderating interest rates and pro-growth policies from incoming president Donald Trump.

The benchmark S&P 500 is up over 23% year-to-date, even with a recent speed bump, and is on pace for its second straight year of gains exceeding 20%, lifted by megacap tech stocks and excitement over the business potential of artificial intelligence.

Investors are more confident about the economy than this time a year ago, with consumers and businesses having absorbed higher interest rates and the Federal Reserve now lowering them - albeit by not as much as hoped. Corporate profits are also expected to be strong, with S&P 500 earnings projected to rise 14% in 2025, according to LSEG IBES.

On the other side of the ledger, inflation remains stubborn, and Wall Street is wary of a rebound that could lead the Fed to change course on its easing cycle. Indeed, stocks pulled back sharply on Wednesday after the central bank projected fewer rate cuts next year as it braced for firmer inflation.

Such prospects could become more likely if Trump implements tariffs on U.S. imports that lead to higher consumer prices. Stock valuations, meanwhile, are around their steepest levels in more than three years, leaving greater potential for turbulence.

"We've been on quite the tear coming off the lows back at the end of 2022. It's been pretty eye-watering," said Garrett Melson, portfolio strategist at Natixis Investment Managers.

"Animal spirits... are certainly running pretty wild right now, but you might need to temper that a little bit as you start to move through the year," said Melson, who thinks the stock market could still produce solid gains of around 10% in 2025 if not the returns of the prior two years.

Wall Street firms are mostly projecting gains for the market next year, with S&P 500 year-end targets ranging from 6,000 to 7,000. The index was last hovering around 5,900.

Optimistic investors can point to a bull market that is neither old nor over-extended, by historic measures.

The current bull market for the S&P 500 that began in October 2022 is less than half as long as the average length of the 10 prior ones, according to Keith Lerner, co-chief investment officer at Truist Advisory Services. The S&P 500's roughly 64% gain during this latest run trails the 108% median gain and 184% average rise of the prior bull markets, according to Lerner.

"If you zoom out a little bit, yes, we have a lot of gains, but if you look at a typical bull market, it suggests that we still have further gains to go," Lerner said.

Other historic signs also bode well. The S&P 500 has gained an average of 12.3% following the eight instances of back-to-back 20% annual gains since 1950, according to Ryan Detrick, chief market strategist at Carson Group, compared to a 9.3% overall average increase over that time. The index increased six of the eight times.

RIDING OUT RATES

Bolstering the upbeat sentiment is the prevailing sense on Wall Street that the economy has weathered the rate hikes the Fed implemented starting in 2022 to quell inflation.

A Natixis Investment Managers survey conducted in recent weeks found 73% of institutional investors said the U.S. will avoid a recession in 2025. That's a sharp turnaround from a year ago, when 62% projected such a downturn in the coming year.

Citigroup's economic surprise index, which measures how economic data performs versus expectations, has been solidly positive for the past two months, another rosy sign for investors.

Adding to expectations of a solid economy, Trump is expected to pursue an agenda that includes tax cuts and deregulation that supports growth.

"We're leaving 2024 on pretty good footing, and we think there is some re-acceleration in 2025," said Sameer Samana, senior global market strategist at Wells Fargo Investment Institute. "Markets tend to front-run the economy, so they will position for that economic re-acceleration sooner rather than later."

However, stocks are also leaving 2024 at elevated valuations: The S&P 500 is trading at nearly 22 times expected earnings over the next 12 months, according to LSEG. That is well above its long-term average of 15.8, and not far from the 22.6 level it reached earlier this month, its highest since early 2021.

Investors maintain that valuations can stay high for long periods and do not necessarily indicate imminent declines. But future gains may rest more on earnings growth, while higher valuations could make stocks more easily rattled by any disappointments.

POLICY PERILS

Risks include policy uncertainty such as Trump's expected push to raise tariffs on imports from China and other trading partners, which analysts estimate could hurt corporate profits.

Higher tariffs could also increase inflation, which is another worry for investors. The pace of inflation has fallen dramatically since hitting 40-year highs in 2022, but remains above the Fed's 2% target. The latest reading of the consumer price index found a 2.7% annual inflation rate.

"How low we can get rates is really going to be dependent on how low we can get inflation," said Michael Reynolds, vice president of investment strategy at Glenmede. "If we see inflation settling out to the 3-ish percent range, we think the Fed's not going to be as aggressive next year."

Glenmede is recommending investors take a neutral posture on overall portfolio risk, including for equities.

"Investors should be what I would call cautiously optimistic," Reynolds said. "We ... have an economy that's showing signs of late-stage expansion alongside valuations that are pretty rich."