Thoughts on How to Approach 2025
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Even though 2024 ended less than spectacularly and the first few days of 2025 have been much the?same, we are still maintaining our positive outlook for US stocks for the year. My beliefs are based on the pillars?of low and stable inflation, continued earnings growth, and broad participation by many companies across the market. I especially like that the profit taking continued in the first few trading days and then the leaders took off to the upside on Friday and Monday of this week. It may seem strange, but I welcomed the end of year pullback so that we could see which markets / sectors/ leading companies pulled back but held above important support levels. This tends to indicate that it was, just that, profit taking, and when the money begins to go back in?it tends to go to the leaders first. Sometimes the old leaders reengage, and sometimes there are new groups that emerge. According to the year ahead, by the team at Ned Davis Research, they have an annual high target of 6,600 on the S&P and Thomas Lee of FundStrat still stands strong at his 7,000 target. These aren't appreciation levels as were seen in '23 and '24, but they are still percentage moves that are above the average and would still be quite attractive.?
Since interest rates have remained stable, and growth and inflation have stayed at levels that have been expected, nothing has really changed in the backdrop. The outlier to this surfaced this week with interest rates. The 10-year US Treasury yield is rising once again, and this could cause a pause in the attractiveness of equities. Since low-risk bonds tend to be a tradeoff of investment dollars to stocks when interest rates rise, I am keeping a close eye on this move in interest rates.? This tends to allow prices to continue in the direction they have been in until there is a change. The “reason why” these rates are back on the rise is the massive Treasury issuance that is going on this week. This is when the Fed has to reissue debt instruments to replace those that are maturing. On Monday the 3-year maturity was auctioned. It did not go well and the rate of interest that it demanded was higher than expected and this drove rates across all maturity levels higher. I believe this is why the markets are continuing to act a bit negatively. Until the various maturities are completed, we will not know where interest rates and the US Dollar end up. This could be worth paying attention to!
The unknown is clearly Trump and his, as yet, unknown agenda. Thus far, it appears that most major companies are sort of "circling the wagons" around President elect Trump prior to his being inaugurated, clearly to have discussions about what the incoming president thinks about the companies and their policies. Based on what we are told by the media and based on the action out of the price levels of the companies, things seem to be going pretty smoothly.?
One of the unknowns is Powell's pace of rate cuts. His dual mandate, as he repeats at virtually every meeting, is solid employment (meaning unemployment doesn't accelerate) and decent economic growth (consistent and rising GDP). To do both of these, and keep inflation at bay, particularly in the face of monstrous?debt levels, will be quite a feat. The new administration?will clearly push for more liquidity to spur growth. How this will be done will have to be a delicate balance between the continued deflation of our AI technology, the cutting of useless government programs by his DOGE team, and the increased costs that are sure to come from immigration changes and the threatened tariffs.?According to Scott Bessent, the new treasury secretary, Trump's policies are pro US dollar and deflationary. These are very difficult bedfellows to be sure.?
There was a terrific article in the Other Voices section of Barron's this past weekend titled, "U.S. Exceptionalism?Will Thrive in a World in Retreat." The point of the article I will go into in a moment, but first, I think it is very important to see what the current trajectory is of the financial markets throughout the world:
The S&P 500 continues on its ascent higher. As can be seen for the year 2024, there were short periods of digestion, but for the most part it was rising at a very consistent slope.?
Now let's take a look at how the developed international market is fairing relative to the S&P. As can be seen by the red line, the international equity market continues to decline relative to the S&P.
Last, let's see how the S&P is doing relative to the emerging market index. I find this an important segregation as the emerging markets (China, Russia, Brazil, and India) represent huge population groups and could be seen differently. As can be seen by the relative red line of this comparison, emerging markets are also having a tough time of it.?
This then brings me back to the article that focused on US exceptionalism. When looking at the global markets, it's beginning to look more like the world is becoming more isolationary than global. Trump continues to rattle his saber on issues related to inequalities in labor costs and therefore ultimately price levels of goods and services. Most at risk will be open, trade dependent economies across Europe, Asia, and much of the emerging market universe. Because they rely so much on US consumption, investors remain lukewarm on these export markets. In contrast, the preference for US equities remains in place in part due to the simple fact that no country is better disposed toward economic autocracy and isolationism than the US. The media would like for you to believe that this is a bad thing, that we are being destructive as a result. But to the contrary, we are acting in the best interests of our people. Before these are feared as bad things, let us remember some important facts.?
It's a small wonder the tariff issue is being discussed so much. And at the same time the US dollar keeps rising which tends to mean that capital continues to flow into US dollar denominated assets- companies, fixed income and equities. Trump knows that given these statistics, if there were ever an economy built for trade powers it is currently the US. This is why this leverage, if used properly, could rid the world of some ills that have plagued us for generations.?The media will be sure to support the complaints of other countries, but this is because it could force them to do what should have been done long ago and not allow them to continue to act as they are. This, I believe, is supported by the “no confidence” votes of late in both Germany and France. These developed economies can see a difficult situation in front of them and are not supportive of their current governing bodies.
So where do our markets sit currently? They seem to be digesting the past few weeks quite well except for our humongous?bond offerings that began this week and seem to be pointing to higher interest rates. These are higher interest rates in the face of falling inflation. This is not a good statement relative to our level of debt. If the debt needs to be sweetened to elicit buyers, this only comes in the form of higher interest rates, and if these higher rates remain sticky and the US dollar doesn't stay high, it could be forecasting some unfriendly times for our economy. Please see the weekly interest rate level of the 10-year US Treasury. As can be seen, it is currently approaching past high-interest rate levels which are not helpful to US equity prices.
Yet at present, the statistics still point to higher markets. If we are to look at the monthly average returns since 1950, the S&P has risen higher over 64% of the time in January when the index is above its 200-day moving average. Those bets are off if the markets are not acting so healthily.?
The last statistic that I will leave you with is what has happened since 1950 when the market has been up over 10% the previous year and is positive in the first 5 trading days of the new year. As can be seen below, the average return is up 13% and this has happened 82% of the time.?
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There are many unknowns on the horizon for calendar 2025, but the backdrop and the statistics seem to still be in an investor's favor. We have another 4-day work week this week with the celebration of Jimmy Carter tomorrow. We certainly hope that not everybody gets too used to these 4-day work weeks as that would clearly take away from US Exceptionalism.?
Ken South, Newport Beach Financial Advisors
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