Let’s talk about next year.
In this first portion of a two-part series, we want to begin to highlight the CFSs outlook for 2025.
This year seemed to stun just about everyone. But to begin 2024, you might remember how we at CFS were out of step with most annual prognostications. We were outliers because of our outsized upside projections for the market in 2024.
But now it’s appropriate to wonder if the party is over.
In this post, we’re going to focus on five data points that lay foundational support for continued momentum in the equity markets going into 2025.
- Fast Or Slow, Don’t Fight a Federal Reserve That’s Cutting Rates
As we know, the media talking heads love to opine on the path of interest rates. In fact, a huge wave of such opinionating occurred just last week.
But as we sit here today, there still is no recession in sight. Gross domestic product growth remains steady, and consumer spending is maintaining its resiliency to underpin the overall economy. Keep in mind, consumer spending represents 70% of all U.S. economic activity.
Furthermore, the core personal consumption expenditures (PCE) index, which excludes food and energy prices, is down to 2.8%. Meanwhile, the headline PCE index sits at just 2.3%.
This alone frees the Fed to continue cutting rates, even if it’s at a slower, more cautious pace. In this chart, it’s clear there’s significant rate-cutting work to do to normalize the current situation:
- Tariffs
There’s been a recent increase in concerns about the inflationary impacts of tariffs from the incoming administration. But let’s reframe this with a simple formula: tariffs lead to talks, which lead to deals.
While some may argue that point, look no further than the first Trump administration for clues on how this could play out. Using that historical context, it's reasonable to expect that any tariff bluster is likely a negotiating ploy on the way to economic policies that are milder than originally feared.
Keep in mind, markets don't need risk-free conditions. Markets move on the gap between expectations and reality. So, outcomes that are merely better than feared are all stocks need to rally.
Below are five potential tariff policies and their potential GDP impact. Note the significant range between the best and worst cases.
If the worst-case outcomes are avoided, as in 2016 and 2020, then one of the market’s potentially biggest pain points could surprise to the upside, which further supports a continued rally.
- 10-Year Treasury Yields
Since the Fed’s first rate cut on Sept. 18, 10-year Treasury yields have risen. Bears point to this daily, saying it makes stocks significantly less attractive.
Their reasoning is that rising 10-year Treasury yields reflect growing structural deficit worries. So, these bears think the bond market will demand to be paid higher interest rates to hold U.S. government debt.
Sounds reasonably logical, right?
Well, we’d argue this is a fear-over-data argument. The recent rise in bond yields primarily reflects better-than-expected economic growth. Let’s remember that economic growth is good news for stocks. This is not to say the deficit is not a risk we absolutely acknowledge but it isn’t a risk currently applicable to the recent rise in the 10-year rates.
Rising 10-year yields have mirrored the rise in the Citi U.S. Economic Surprise Index, which measures how much economic data is beating or missing consensus Wall Street forecasts. The two datasets have moved in virtual lockstep over the past few months:
- What is the Risk Premium?
The equity risk premium is the spread between the S&P 500* earnings yield and the 10-year Treasury yield. Currently the ERP is only 0.3%, reflecting the gap between the S&P 500’s 12-month forward earnings yield of 4.5% and the 10-year Treasury yield of 4.2%.
Historically, the ERP averages about 3%. Some would argue that a low ERP signals that stocks are a bad bet relative to bonds.
But when you test this thesis from a historical standpoint, history shows that when the S&P 500’s ERP is between zero and one (as it is now), the average gain for stocks over the next year is 12.4% versus the overall S&P 500 average gain of 9.1%:
- Investor Sentiment is Far from Frothy
There is a cycle to bull markets. They are born in despair, mature on skepticism, loom on optimism, and finally die on euphoria.
We think it's reasonable to believe that we’ve transitioned from skepticism to cautious optimism. But the latest investor sentiment survey proves how widespread euphoria is still a long way off.
A widely accepted measure of this sentiment is the American Association of Individual Investors’ survey of its 2 million members to see how they're feeling about stocks. Here’s where it stands as of late November:
If you go back to 1987, the four-week average of bullish minus bearish sentiment readings is 6.5%. The latest reading has bulls outnumbering bears by 10.5%. That’s only slightly above average since the late 1980s.
This is nowhere near euphoria when looking broadly at historical data.
Potential Risks in Part Two
As of now, understanding these data points begins to provide us with an optimistic, data-driven perspective as the calendar turns to next year.
In part two of our 2025 outlook, we’ll discuss additional data and dig into the potential risks ahead.
Taking the two parts together, Cornerstone’s full 2025 outlook provides a foundational expectation for equities to continue gaining ground at least through the first half of next year, even in the face of headwinds.
* Links to third-party websites are being provided for informational purposes only. CoreCap is not affiliated with and does not endorse, authorize, or sponsor any of the listed websites or their respective sponsors. CoreCap is not responsible for the content of any third-party website or the collection or use of information regarding any websites users and/or members.
*Past performance does not guarantee future results.
*Investing involves risk and you may incur a profit or loss regardless of strategy selected.
* The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market.
Securities sold through CoreCap Investments, LLC. Advisory services offered by CoreCap Advisors, LLC. Cornerstone Financial and CoreCap are separate and unaffiliated entities.