There are various yardsticks used to estimate the direction of the stock market for a given year based on the performance of the stock market in January. Some people take the first ten trading days as direction. Others use the entire month.
Mark Hulbert has been studying the stock market for a long time. His Hulbert Ratings Service tracks the performance of various investment funds. As an aside, Hulbert tracks various stock correlations to see if any of them are statistically significant. According to Hulbert in his article published on marketwatch.com, on January 31,2025 quoting research in The International Review of Financial Analysis by professors at Iowa and Tennessee- Knoxville, the key to predicting the market for a given year is not the direction of the S&P 500 in January, but the University of Michigan survey of consumer sentiment. If the index is higher in January than December, the market will go up that year. If the sentiment index is lower in January than in December, the market will finish the year lower.
This year the index declined to 71.1 from 74 in December. This was a larger decline than the consensus forecast, which had put the index in January at 73.2. The S&P 500 Index appreciated 2.7 percent in January 2025. Thus, there was a divergence between eroding consumer confidence and an appreciating stock market. According to Hulbert, the lower consumer confidence is a better indicator for the rest of the year than the stock market’s one-month progress.
Consumer confidence is the sum of several factors. Inflation, especially in goods that are not deferable like insurance or the price of eggs, job security, interest rates, a feeling as to the stability of the personal environment and the like. Some of these things can be controlled. Most cannot. They also affect different income groups differently. Lower income households have fewer options aside from cutting back. For higher income households these factors are more easily addressed if not ignored. Higher income households have more investment assets whose appreciation insulates them from adversity. Lower income households tend not to have investment assets in the same proportion and thus have fewer offsets.
Adding to this is a new political administration. While every administration differs from its predecessor, the pace of change this year has been rather rapid. Some argue that the pace of change is not legal. However, in many cases it seems that it is not legalities that have been violated but social norms. No one has witnessed this pace of change because no one has ever tried it. Presumably, the courts will decide on what is legal. The question is whether, given the dismantling of institutions, there will be anything left to resurrect even if their existence was guaranteed by law.
Trying to invest in this environment is especially challenging. If consumers are cutting back, and they represent about 70 percent of all economic activity, will the economy follow closely behind? Late-stage industries like capital goods seem to have little incremental demand given the profile of this cycle. Export industries are not candidates for growth in the middle of a trade war. Some industries may replace imports if they can come up with qualified workers. The talk of cutting back government spending can tip the economy into recession, if there does not seem to be an offset. As of this writing, there is no discussion of tax cuts for the working class. Even if there were, getting consumers to have the willingness to spend requires having some faith in the future. The current situation does not seem to provide that.
Advocates for the current approach say that incrementalism does not work, and that a shock to the system is what is needed to move things forward. That may well be. We will soon find out.
The Economy
After 2024 ended on a high note, the economy is showing signs of stalling. Job openings are beginning to slow. Grocery prices have not materially declined. Trade with other countries is showing some signs of slowing. Such slowing will surely accelerate as tariffs are imposed.
Some companies are forecasting flat earnings in 2025 despite nice gains this past year. While the reasons vary, in essence there is at this point no plausible case for aggregate material economic growth in 2025. In a way this is to be expected, as economic growth has done so well for so long. Still, decelerating growth tends to catch some unawares.
Interest Rates
Interest rates have been higher than expected, given the rate of inflation over the past year. Part of this is the need to attract foreign investors to buy US Government debt. Another is the ongoing deficits being run by the government which require funding. The line item for interest expense for the US government has more than doubled in the past two years. This is less a function of the volume of debt than the fact that, as various bonds mature, newly issued bonds are issued at higher coupon rates to replace them.
Some still are expecting the Federal Reserve to cut interest rates this year at least once if not more. However, inflation is in effect making a case for interest rate increases and not reductions. Those who think we have seen the peak in interest rates this cycle may be mistaken.
The Stock Market
Stocks are looking a bit pale. Between riding each tariff announcement and retraction down and up, there are some more significant dynamics at work.
A lot of the big tech stocks are showing slower rates of revenue and earnings growth. This is in part because of their shear size. In some cases, it is because of their dependency on foreign sales which are becoming problematic as the world slows down and tariffs make growth more challenging.
With decelerating revenues and earnings growth comes sometimes lower stock prices. If it happens often enough it is stock market correction. Whether this impacts an investors’ portfolio depends on the time frame. According to the retired portfolio manager Peter Lynch, markets go down at least ten percent one year in three and two years in five. That has not happened in a while. Perhaps we are due to a reversion to the historical schedule. If we are, there are any number of new investors who will be in for a shock.
Warren M. Barnett, CFA
February 07, 2025
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