We are at this writing at record levels for most of the stock indexes. The line of greatest credibility for the forecasting profession is to predict an extension of this trend into the future. If only it were so easy. The first year of a presidential term is usually marked by greater than average levels of volatility as new tax and spending priorities are implemented. Each new policy will have its own list of winners and losers.
Some of the losers may be less immediately apparent than others. For example, the urge to deport millions of immigrant workers can act to drive up food and housing costs, as foreign workers are key in these industries. To the point being made that only criminals will be deported: there are not enough of them to make the quota of deporting a million people a year for ten years. Besides, criminals are already being deported. Like the Muslim ban of the first term, the rationale for this is not entirely clear or, to the extent it is, not justified. Cooler heads may prevail, but probably not in time to prevent major disruptions in the economy, to say nothing of the lives of those involved.
Aside from items like planned tariffs to presumably pay for tax cuts, the balance of the threats and opportunities reside with the stock market itself. High valuations were addressed last month. They have gone higher. Especially in the area of technology in general (now 40 percent of the market’s total value) and Artificial Intelligence (AI) in particular, investors may want to think in terms of taking profits. When the correction comes, if history is any guide there will not be enough time to sell, except at lower prices.
And a correction will come. Already there is talk about whether AI can live up to its expectations as a new growth engine, given the infrastructure expense incurred in supporting it. Profit growth seems to be hovering around five percent next year. This profit forecast assumes that companies do not lose access to export markets as the result of tariffs imposed on other countries. Tit for tat tariffs are how trade wars are started. The last one, started in 1930, caused the recessions brought on by the stock market collapse of 1929 to become the Great Depression.
So, what are the bright spots in 2025? While tentative, there seems to be a number of initiatives afoot to construct entry-level housing. This should help alleviate one source of persistent inflation. Food costs are somewhat captive to immigrant labor, but there is some reason for hope that the rate of change will decline. Wages are strong and employment is robust. Property insurance costs are still rising. At some point the return on writing business will attract other entrants and premiums will decline. State and local taxes keep going up as such governments lack the ability to overspend and print money as the federal government is known to do.
In terms of industries: health care has perhaps the most guaranteed projected income given its positive correlation to demographics. Aside from that, this will become more of a sharpshooter’s market. Finding investments will be less of a broad-brush exercise and more of individual analysis. This will be especially true if AI disappoints. There will not be an exit big enough to accommodate everyone wanting to leave the market if that happens.
Forecasting 2025 would not be complete without some mention of cryptocurrency. This should be the year that either crypto is appreciated beyond those who make money off the same, or it is exposed as a house of cards. The incoming administration has gone to great lengths to legitimize cryptocurrencies, no doubt in response to campaign donations
that came their way in 2024. At the end of the day, crypto is the providence of no country. It has no one backing it. It is an effortless way to move funds between countries without supervision. In this sense it is the first choice of terrorists and money launderers. Whatever attributes taken up by legitimate organizations have to be weighed against its ability to do harm.
Meanwhile, the casino plays on. A new online firm, crypto.com, has started selling stock options with a 20-minute expiration. In effect, the company bets against the option buyer that a stock will not move enough in 20 minutes to be profitable to the option holder. Coming on the heels of zero-day options, where the price has to move before 4:00 pm ET the same day, record amounts of margin debt and the like would seem to suggest that stocks are being used less for investment and more for speculation. Not a good sign.
The Economy
The economy is doing quite well. Jobs are plentiful and in demand, estimates of economic growth for this quarter have been revised upwards, the dollar is stable in terms of international value, and most surveys of consumers are incredibly positive.
The near- and long-term issue is how will the economy respond to the changes being made by the incoming administration. At this point, the talk of change is all talk. After January 20, there will be pressure to implement campaign promises. This uncertainty as to what will happen will probably cause the economy to stall going into the new year. What happens after that depends on how the new administration’s edicts are received by the economic actors that in turn influence events.
Inflation
Inflation in 2025 will depend on the extent of economic disruption. At this time, it is assumed that inflation will increase in 2025, driven by an expanding deficit and some withdrawal of foreign support in terms of bond purchases. Tariffs, a trade war and deportations would all add to the inflation mix, forcing the rate higher.
Interest Rates
Interest rates will trend higher in 2025. Bond investors, tired of being paid back in depreciated dollars, will demand a premium to the perceived inflation rate. Should inflation accelerate in 2025, expect interest rates to do the same.
The Stock Market
Contrary to widespread belief, the stock market does not exist to make all its participants wealthy. The stock market exists so that companies can raise capital by selling stock to the public. At times like this, when it seems everything is going up, it is easy to forget this.
Measuring the stock market’s value is a function of taking the future estimate of growth (about 5 percent per year) compared to its value. The stock market is currently about twenty-four, for an earnings yield of just over 4 percent. Add the average dividend of 1.1 percent gives you a total value of just over 5 percent.
Investments do best when future earnings are higher, and P/E ratios are lower making earnings yield higher. For example, in 2010 the P/E ratio was six for an earnings yield of over 18 percent, growth was about 6 percent and dividend yield was over 4 percent.
If all this sounds esoteric, consider this: presumably, no one knows their company better than the people who run them. They have been net sellers of stock in their own firms at a near-record rate. However, there are always reasons for corporate insiders to sell, the volume of trade in selling their own company’s shares is of note.
Warren M. Barnett, CFA
December 10, 2024
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