By Linh Tran, Market Analyst at XS.com
The S&P 500 enters the fourth quarter on a sustainably positive note. The current macroeconomic backdrop suggests that the U.S. economy remains on track for a “soft landing”—growth is cooling but not contracting, while inflation continues to ease gradually toward the Federal Reserve’s 2% target.
The temporary U.S. government shutdown has delayed the release of some key economic data, yet the figures already published, such as ISM and consumer confidence, reflect a moderation in demand that remains strong enough to sustain growth. In this environment, the Federal Reserve (Fed) has reason to maintain a dovish tone, avoiding an unnecessary tightening of financial conditions while the economy remains in a delicate balance. This is a crucial factor supporting the S&P 500’s more sustainable uptrend.
In terms of corporate earnings, the recovery cycle is gradually taking shape with improving quality. Revenue growth may slow, but profit margins are being supported by lower input costs, stable wages, and particularly by productivity gains driven by heavy investment in artificial intelligence (AI) and cloud computing. Large corporations have demonstrated greater financial discipline following the 2022–2023 adjustment period, focusing on cost optimization rather than aggressive expansion. This has created upside potential for earnings per share (EPS) in the upcoming quarters, especially within the semiconductor, industrial automation, healthcare, and financial sectors.
The interest rate landscape is also shifting from “higher for longer” toward “stable with a bias to ease.” The 10-year Treasury yield appears to have formed a short-term top, while the weaker U.S. dollar has improved the translated profits of multinational companies and loosened overall financial conditions. Credit markets remain well-functioning, and yield spreads are at healthy levels, indicating low systemic risk. As real interest rates begin to cool, equities remain relatively attractive compared to bonds, as long as the earnings outlook continues to improve and no unexpected macro shocks occur.
While the S&P 500’s valuation is above its long-term average, it remains justifiable if the current “AI wave” is viewed as the start of a new productivity cycle. Although concentration risk among mega-cap stocks persists, market breadth has improved significantly, signaling that the rally is broadening across multiple sectors rather than being driven solely by a handful of leaders. If this rotation of capital flows continues—from technology toward industrials, financials, and healthcare—the index’s uptrend could become more durable and balanced.
Nonetheless, several key risks remain. A negative surprise in labor or inflation data could prompt the Fed to keep policy restrictive for longer, pressuring yields and equity valuations. Additionally, geopolitical tensions in the Middle East or Europe could impact oil prices and inflation expectations. Domestically, political uncertainty—particularly over the budget negotiations and the 2025 presidential election—may add to short-term volatility.
Looking ahead to the medium term, the base-case scenario remains one of slow but steady growth, continued disinflation, and a gradual rate-cutting cycle by the Fed toward year-end. Against this backdrop, the S&P 500 is expected to maintain a measured upward trajectory, supported by improving corporate earnings, stable valuations, and persistent institutional inflows. A sideways consolidation near current highs, followed by a breakout to new levels, appears to be the most plausible scenario.
In the near term, although risks persist—particularly high valuations and political uncertainty—the overall outlook remains constructive, reflecting confidence that the U.S. economy’s new growth cycle is entering a more stable and sustainable phase. Still, short-term technical pullbacks are likely and even healthy, as markets adjust to the evolving mix of policy and geopolitical risks.