Theoretically, the stock market could crash for any number of reasons. A big political event, a pandemic, or a financial crisis could send share prices plunging without notice.
In practical terms, however, there are some things that are easier to anticipate than others. And one thing in particular stands out to me as an obvious potential threat in 2025.
Inflation
As I see it, the biggest risk with the stock market right now is the possibility of US inflation picking up. This is worth keeping a close eye on for investors on both sides of the Atlantic.
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The US is introducing 25% tariffs on imported steel and aluminium. And while that might benefit the likes of Alcoa and Steel Dynamics, it could be a problem for other businesses.
The obvious examples are international steel companies, which might see lower demand. But restricting imports could cause input costs to rise for manufacturers.
If businesses look to pass these on, the result will be higher prices for US consumers. In other words – tariffs could give rise to inflation.
Share prices
If this happens, investors are likely to look for better returns from their assets. In the case of the bond market, this means higher yields.
US inflation is currently 3%. But if it reaches 3.5% (where it was a year ago) investors buying bonds with a 4.5% yield (the current US 10-year level) don’t stand to make much in real terms.
Higher inflation is therefore likely to weigh on bond prices. And if this happens, bonds could start looking attractive compared to stocks – causing share prices to come down as well.
The US currently makes up more than half of the global stock market. So a stock market crash across the Atlantic could weigh on share prices everywhere else – including the UK.
What should investors do?
Forecasting a stock market crash is nearly impossible. But one thing investors can do is look for shares that are already trading at prices that reflect some pessimistic assumptions.
Diageo (LSE:DGE) is an obvious example. The stock is currently at its lowest price-to-earnings (P/E) multiple in a decade, meaning it’s already cheap compared to where it usually trades.
There are reasons for this. A lot of the FTSE 100 firm’s products have to be produced in certain geographies, meaning there’s no way to make them in the US – and thus no way around tariffs.
This is a definite risk, but the scale of Diageo’s distribution network is an important asset. Over the long term, this should be a big advantage when it comes to competing for market share.
Eyes open
I think it’s important for investors to pay attention to what’s going on in the stock market. This can help make sense of why share prices are moving the way they are.
Right now, the biggest risk I see is the threat of inflation picking up in the US. But this may or may not result in a stock market crash – and I don’t think betting on this is a good idea.
A better plan, in my view, is looking for opportunities where investors are already factoring this in. And I think Diageo is an example of a stock that’s worth considering at today’s prices.
