It's not just 2025 optimism lifting the stock market

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For all the talk of an AI bubble, of exorbitant valuations, and of investor exuberance, analysts are finding more reasons to be bullish, and not just for the next quarter.

But the impacts of tariffs are still unfurling. And the Fed’s latest easing came with additional risks and uncertainty. Central bankers aren’t just battling pricing pressures but the real prospect of rising unemployment — not to mention incursions against their own independence. The reasons to be careful are also piling up.

Part of understanding why market optimism seems to be winning out — despite the factors weighing against it — is the timeline experts and investors are using to derive their optimism. It isn’t just the muscular corporate results expected for the rest of the year that are powering lofty expectations. Projected returns for 2026 and even 2027 are driving the growth story too, with AI efficiencies and a more dovish Fed boosting corporate fundamentals.

By one measure, according to an analysis by DataTrek co-founder Nicholas Colas, the S&P 500 (^GSPC) is back to trading at dot-com era levels. Its price-to-earnings ratio based on trailing 10-year earnings is now 40x. That underscores the benchmark index’s impressive returns in a year of economic tumult and historical parallels that hint at overextension.

That’s not to say that we’re on the verge of an epic sell-off. The math is more suggestive than prophetic. But it does prompt people interested in the stock market to consider what it would take to keep the party going.

“The S&P 500 is not just historically expensive on 2026 earnings but also based on an optimistic view of 2027 results,” Colas wrote in a note to clients Sunday.

For the S&P to maintain its estimated earnings multiple, the index would need to grow its earnings 13.4% next year and another 15% in 2027.

“Investor confidence must remain well above average over the next two years for the S&P to match its long-run rate of return,” he wrote.

Corporate profit margins holding up exceptionally well is one way to get there.

As our former colleague Sam Ro wrotein his TKer newsletter, corporations have proven adept at maintaining historically high margins in recent years, through the shocks of the pandemic, high inflation, tight monetary policy, and, most recently, higher tariffs.

Not only is there momentum, but the margin expansion touted this year by Big Tech companies is expected to broaden to other industries in 2026 from efficiency and productivity gains, AI, and the labor market. After all, the same labor market woes that forced the Fed to initiate a cutting cycle can also work to boost margins: Slower wage growth for workers means lowered costs for corporations.

But there’s a delicate balancing act at play.

A more resilient labor market might force the Fed to hold steady, rather than initiate a months-long campaign of cutting. And Fed policymakers disagree over which of its mandates should take precedence.

How that shakes out will certainly do its part to dictate corporate costs, margin growth, and earnings. And at the end of the line, stock prices.

Hamza Shaban is a reporter for Yahoo Finance covering markets and the economy. Follow Hamza on X @hshaban.

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