2025 Market Outlook

Our outlook for 2024 centered around four possible scenarios pertaining to economic growth, inflation and the direction of interest rates set by the Federal Reserve (Fed). With the market near all-time highs back in January 2024, investors entered the year mostly wary of a recession and re-accelerating inflation. Those outcomes did not materialize and as a result the S&P 500 index posted its second consecutive year of greater than 20% returns. What occurred was actually a combination of two scenarios that we thought had an elevated probability of happening, a “soft-landing” and higher interest rates for longer (or “no-landing”).

For most of the year investors were enthusiastic about better-than-expected earnings and economic data. Meanwhile, inflation receded, and the Fed had begun cutting interest rates. The goldilocks scenario of a soft-landing was playing out. During the last several months of the year, however, inflation started showing signs of stickiness and the Fed’s more recent hawkish comments have renewed concerns that interest rates may need to stay higher for longer. An indication of this concern is reflected in the rise in Treasury yields, notably the 10-year U.S. Treasury Note, which has risen meaningfully since September (higher long-term yields can be a sign of rising inflation expectations).

We will discuss in this communication how current conditions do not reflect a typical economic cycle and what this may mean for the markets in 2025. With a new administration taking office and the Fed back to “wait and see” mode as it relates to the direction of interest rates, the uncertainty of fiscal and monetary policy adds complexity to the outlook. In other words, interest rates appear to be stuck at current levels, and the market will be looking for indications of how economic activity and earnings growth will be impacted by the heightened level of rates we have not experienced in nearly two decades.

We remain optimistic about the resiliency of the U.S. economy and confident in the outlook for balanced and diversified portfolios. It is also important, and core to our investment philosophy, that we continuously look to rebalance investments that drift away from desired target levels, optimize for tax efficiency, and adjust portfolio risk when changes occur within your financial plan.  

Source: Q4 2024 Total Return as of 12/31/2024, Bloomberg

• U.S. equity markets have driven global returns, which has led to the U.S. making up roughly two thirds of the global stock market (MSCI ACWI)[1]. Altium’s investment committee continues to recommend an overweight to U.S. stocks.

• While the U.S. markets all broadly outpaced the international markets, leading all asset classes by a wide margin was U.S. large cap stocks. Market breadth was positive, but the Magnificent 7 dominated returns. (The Magnificent 7 refers to the following stocks: Apple, Microsoft, Amazon, Alphabet, Meta, Nvidia, and Tesla) This group of mega cap stocks accounted for roughly 53% of the S&P 500’s 2024 total return, which means the 25% total return would have been 11.75% without them.[2]

• The Bloomberg U.S. Aggregate bond index, a broad measure of US investment grade bonds, fell 1.64% in December and finished the year up a modest 1.25%. Expectations for fixed income markets were high leading into 2024, but after a strong start bonds sold off late in the year as concerns over inflation and higher interest rates for longer resurfaced. For example, the yield on the 10-year U.S. Treasury increased from 3.6% in September to nearly 4.8% in January, applying downward pressure on the price of bonds.[1]

THE CHALLENGE OF LANDING THIS ECONOMY

The goal of a soft landing is to slow down economic activity enough so that inflation is brought under control, yet not too much where it ends in a recession. While the economy has returned to modest growth without a period of severe recession, we are mindful that inflation is not quite down to target levels and therefore remains a significant catalyst to watch this year. Thus, a no-landing scenario is now back in play, where the Fed must keep the policy rate relatively high to try and prevent inflation from re-accelerating. With interest rates poised to remain higher for a longer period of time, rate sensitive and cyclical parts of the economy will be squeezed, and servicing debt becomes harder for both consumers, corporations, and the government.

We maintain that it is going to be difficult to slow down the economy. While the strength of consumer spending is consistent with stable labor conditions and stock market appreciation, the economy is still riding the effects of outsized government spending and excess liquidity. Furthermore, corporations have invested massive amounts of money in capital expenditures, a trend we expect to continue due to the rapid growth of AI and expectations for de-regulation with the incoming administration.

For now, real wage growth and stock market gains have both helped offset the impact of inflation on consumers, particularly with high-net worth individuals. Additionally, many individuals and corporations opportunistically refinanced their debt in the years after Covid, again hampering the financial impact that would have normally been seen with higher-than-normal interest rates. Plainly stated, current interest rate levels may not be effectively restricting growth.

Thus, successfully landing the economy continues to be a challenge. The Fed will look to maintain a balance between employment and inflation, and if we assume based on current indications that the job market remains stable, we can expect interest rates to be held at or near current levels before they can be further reduced to more historically normalized levels. While we have seen some reduction in inflation within supply driven segments of the economy, it is hard to see an easy cure for segments such as housing, food and healthcare which remain in such high demand.

UNDERSTANDING THIS ECONOMIC CYCLE

Back in 2022-2023, the Fed began raising interest rates to bring down surging levels of inflation. In all the Fed raised rates eleven times during that period, in what was amongst the most aggressive cycle of raising rates in history.[3] Then in December of 2023 the Fed signaled that it would soon pivot its policy towards reducing rates to more normalized levels, feeling that inflation had stabilized and was trending towards target levels. Heading into 2024, Altium’s economic model indicated that we had re-entered late cycle levels of activity (based on our assessment of where the U.S. economy falls within the initial recovery, expansion, peak, and contraction stages of an economic cycle).

Consistent with a no-landing scenario, Altium’s economic model is now signaling peak or mature levels of activity. The peak of a cycle is when growth hits its maximum rate, and economic indicators stabilize in advance of a period of contraction. Changes in GDP are the most popular indicator of the nation’s overall economic health. The U.S. economy expanded an annualized 3.1% in the third quarter of 2024, reflecting an increase in consumer spending, exports, business investment, and federal government spending. GDP growth for 2024 is expected to be around 2.5%, and current Fed projections have GDP stabilizing around 2% for 2025 and 2026.[4]

The next stage of the cycle would be a contraction and thus the risk of a recession rises, however, the peak stage can last for years. Therefore, while we may be closer to the end of this cycle than the beginning, it does not necessarily mean a recession is on the horizon. Based on recent economic data, the risks of a recession are low. The job market is healthy, consumer spending is strong, and inflation has been stable. Furthermore, the amount of money supply or liquidity that consumers have on hand has increased and is back to 2022 levels.

SIGNIFICANT 2025 CATALYSTS

Fed Funds Rate: The Fed cut interest rates by 1% in 2024, and now anticipates two additional cuts in 2025. However, the Fed has made it clear that it will want to see lower core inflation before it cuts interest rates further. Of course, this also depends on the labor market which most recently strengthened in December. Again – a stable job market with modest GDP growth, means the Fed can hold rates steady at current levels. A re-acceleration of economic growth could even bring rate hikes back into the conversation.

Expectations Under the Incoming Administration: Expectations have been set by President-elect Trump and his administration, specifically for pro-growth initiatives and a de-regulated environment. In the coming weeks and months, we anticipate learning more about the direction of taxes, tariffs, immigration policy and government spending. The equity market has priced in some optimism, and therefore, we expect that any negative shift in policy expectations could impact stock valuations.

Bond Yields: Rising Treasury yields are consistent with the confidence that investors have in the economy and growth expectations heading into 2025, yet this movement also signals higher inflation expectations. Higher rates put greater stress on the government to service its ballooning debt levels and influences rates consumers and businesses pay. Investors will be monitoring bond yields as an indicator of future Fed policy and outlook for the stock market.

Market Breadth: A small group of stocks represented a big portion of the annual S&P 500 gains in 2024, led by stocks associated with the AI theme. Outside of the top seven stocks in the index, the remaining constituents accounted for less than half of the gains. While spending on AI remains strong, we expect investors will begin paying closer attention to see how such spending has translated to earnings. With more attention on valuations for these AI related stocks, we would expect more modest return expectations to follow.

SUMMARY

Despite muted expectations at the beginning of 2024, the year was full of surprises and elevated volatility amid diverging global economies and asset class returns. Risk assets, like U.S. equities had another strong year fueled by strong earnings, continued investment in the technology sector (AI), and expectations for deregulation under a new administration. Coming into 2024, consensus estimates projected U.S. growth to slow, labor conditions to weaken, inflation to migrate toward the Fed’s 2% target, and the Fed to begin an interest rate cut cycle. Much to the market’s surprise, the U.S. economy remained stronger than expected, the labor market was resilient, inflation receded but not to target levels, and as a result the Fed cut rates less than market expectations.

A couple of weeks now into the new year, highlighted by increased market volatility, it’s clear that investors are looking for direction on what the Fed’s terminal interest rate will be and when they will get there. The market has shifted Fed rate cut expectations further out into 2025 and the Fed has indicated that based on the current balance between the job market and inflation, they are in no rush to cut rates further. Treasury yields have risen steadily since September, back to levels reached in late 2023 which were the highest in nearly two decades (The 10-year U.S. Treasury approached 4.8%).[5] Higher yields have provided further evidence that investors expect the economy to continue to grow and for inflation to remain elevated and possibly re-accelerate.

We believe the economy is in its late cycle, characterized by moderate and steady growth, a stable job market, and high interest rates. While a contraction would eventually be the next stage of the cycle, we do not see recession risks being high at this point. The U.S. economy has proven to be resilient, earnings growth has broadened, corporate spending on AI is robust, and with the possibility for pro-growth initiatives from the incoming administration creates a favorable backdrop for the stock market. Furthermore, for balanced portfolios we see absolute fixed income yields as attractive and we recommend investing in high quality, investment grade bonds in a diversified fixed income portfolio. Managed appropriately, we can select bonds across attractive segments of the yield curve and be positioned to respond to changing conditions.

APPENDIX

Chart A: 2024 Total Return of Major Asset Class Indexes

Source: Bloomberg; 2024 Total Return, MSCI EAFE, MSCI Emerging market, S&P 500, Barclays Agg & Barclays Muni index; 09/30/24

1. Source: Bloomberg: S&P 500 Total Return Index; Emerging Markets Stock Index = MSCI Emerging Markets Net Total Return Index; International Markets Stock Index = MSCI EAFE Total Return Index. Bloomberg Barclays Aggregate Bond Index
2. Source: https://www.spglobal.com/spdji/en/commentary/article/us-equities-market-attributes/
3. Source: https://www.federalreserve.gov/econres/notes/feds-notes/lessons-from-past-monetary-easing-cycles-20240531.html#:~:text=In%20other%20inflation%2Dsuccesses%2C%20taming,around%205%20percent%20in%201983.
4. Source: https://tradingeconomics.com/united-states/gdp-growth & https://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20241218.pdf
5. Source: https://tradingeconomics.com/united-states/government-bond-yield

IMPORTANT DISCLOSURE

Altium is a group comprised of investment professionals registered with Hightower Advisors, LLC, an SEC registered investment adviser. Registration as an investment adviser does not imply a certain level of skill or training. Some investment professionals may also be registered with Hightower Securities, LLC, member FINRA and SIPC. Advisory services are offered through Hightower Advisors, LLC. Securities are offered through Hightower Securities, LLC. This is not an offer to buy or sell securities. No investment process is free of risk, and there is no guarantee that the investment process or the investment opportunities referenced herein will be profitable. Past performance is neither indicative nor a guarantee of future results. The investment opportunities referenced herein may not be suitable for all investors. All data or other information referenced herein is from sources believed to be reliable. Any opinions, news, research, analyses, prices, or other data or information contained in this presentation is provided as general market commentary and does not constitute investment advice. Altium and Hightower Advisors, LLC or any of its affiliates make no representations or warranties express or implied as to the accuracy or completeness of the information or for statements or errors or omissions, or results obtained from the use of this information. Altium and Hightower Advisors, LLC assume no liability for any action made or taken in reliance on or relating in any way to this information. The information is provided as of the date referenced in the document. Such data and other information are subject to change without notice. This document was created for informational purposes only; the opinions expressed herein are solely those of the author(s) and do not represent those of Hightower Advisors, LLC, or any of its affiliates. This material was not intended or written to be used or presented to any entity as tax or legal advice. Clients are urged to consult their tax and/or legal advisor for related questions.