Published January 3, 2025
Below we provide another couple of 2025 outlooks. First from Jim Paulsen of The Leuthold Group. That is followed by investment house Apollo’s assessment of risks and opportunities. There is a heightened level of uncertainty, which markets have been responding to in recent weeks as the first commentary notes. Nonetheless, the strength of the Mag 7 has greatly overshadowed the market’s underlying weakness in recent weeks, leaving indexes largely near record highs and posting a strong 2024.
Here’s Marketwatch’s intro of Jim Paulsen’s comments:
“The end of 2024 is nigh and can’t come soon enough for investors seeing anything but a Santa Rally lately.
Some may blame the Federal Reserve’s rollback of expectations for interest rate cuts, as it worries strong U.S. growth may reignite inflation. Our call of the day from Jim Paulsen, chief investment strategist of The Leuthold Group, sees things differently.
“Although policy officials and investors appear increasingly anxious about the potential for overheated economic growth, I think the more likely outcome for 2025 is an unexpected economic slowdown,” Paulsen says, where he cautions such a surprise could ultimately lead to a pullback in the stock market of at least 10%.
He offers up several examples of weakening growth, such as the Citi Economic Surprise Index—a rise means economic reports have come in stronger than expected, and declines mean economic momentum is trending below expectations. Paulsen’s chart compares that index with the 10-year Treasury yield lagged behind or pushed forward by three months:
Based on history going back to 2003, movements in bond yields have often led to economic surprises, and declining yields have meant an improving economy three months out, and vice versa, he notes. But bond yields, hovering near 4.6%—they hit 4.63% last week—suggest to him the economic surprise index will slow to -35 in the first quarter, slowing GDP as well.
While Paulsen says healthy business and household sectors will likely keep a recession at bay next year, if real GDP slows from a current 2.7% pace to 2% or less, recession fears will dominate financial discussions, drive down profit forecasts and feed through to stocks.
He also looked at the U.S. Financial Conditions Index, which has been worsening since early December. “As illustrated, two other times during the last 18 months, even modest declines in this index led to significant stock market events,” he said, pointing to stock pullbacks of October 2023 and last summer’s rare “Magnificent 7” slump.
“The most recent decline in financial conditions is not yet nearly as pronounced as the last two but it wouldn’t be surprising if financial conditions continue worsening somewhat as economic growth slows further in the new year,” he said.
Paulsen rattled off a number of concerning issues where stocks are concerned, such as deteriorating breadth, where the number of U.S.-listed stocks climbing relative to the number falling has dropping since early October. His read from that is investors are increasingly cautious, noting also underperformance by cyclical and more aggressive stocks since mid-November.
“Since most currently believe the economy is healthy, if not too strong, any meaningful slowdown will come as a surprise. And a ‘surprising slowdown’ which heightens fears could pause the stock market run if not possibly produce a 10% to 15% correction,” cautions Paulsen.
But given corrections are tough to call, he says “most should stay invested since the bull market seems likely to continue during 2025 even if it experiences a bump or two along the way.” That said, a small shift away from cyclical and other “traditionally aggressive investments” toward more defensive ones, may make sense, he says.
The likelihood of a correction and how deep it goes depends much on how technology sector favorites perform in 2025, says Paulsen. If that strength continues, a correction can be avoided, with any slowdown for those stocks a risk. In the below chart he overlays the relative performance of the S&P 500 tech sector with the U.S. financial conditions index:
The last four years have seen obvious close correlation, and in the past a worsening of financial conditions has led to tech underperformance that infects the entire market, Paulsen notes. “So, the primary question for investors in 2025 may be how much will financial conditions deteriorate as the economy slows next year, and how much will this impact technology stocks?”
Below are excerpts from Torsten Slok’s outlook. Mr. Slok is the Chief Economist at Apollo Investments. We begin with his summary of Key Takeaways:
KEY TAKEAWAYS
The outlook for the US economy remains strong with no signs of a major slowdown going into 2025. We continue to see interest rates staying higher for longer on a relative basis, regardless of the Federal Reserve’s ongoing monetary easing campaign.
It is too early to assess the impact of potential new policies following Donald Trump’s election as US president. That said, if implemented, his key policy objectives—lower taxes, higher tariffs, and reduced immigration—could increase rates, boost asset prices, drive inflation, and strengthen the dollar.
The US economy has charted its own path in the post pandemic world, and it is diverging from both its own historical performance in a context of higher rates as well as its historical correlation to other developed economies, especially Europe and Japan.
Why? Because: •
The US economy has proven to be much less sensitive to the Fed’s interest rates hikes than in years past due to key idiosyncrasies (i.e., large, liquid, and long-duration fixed-rate markets for mortgages and corporate bonds), which have allowed both individuals and corporations to “lock in” rock-bottom interest rates for periods of up to 30 years.
The US is experiencing a surge in corporate and research spending on the back of the Artificial Intelligence (AI) revolution—a dynamic not seen in other developing nations or even China. This “AI boom” is structural, widespread and pervasive, ranging from investments by tech giants in the development of AI itself to the infrastructure supporting it, from semiconductor design and manufacturing to the building of data centers, increased energy generation needs, and further automation of supply chains.
The US was unique on its way out of the Covid pandemic in terms of fiscal support to the economy. It has outspent other developed nations by a large margin, providing strong tailwinds to economic growth through the enactment of key pieces of legislation, such as the CHIPS and Science Act (2022), the Inflation Reduction Act (2022), the Infrastructure Investment and Jobs Act (2021), and others. The Federal government’s investments in green energy and infrastructure, along with private sector investments in AI, have been crucial to the nation’s economic resilience. Fiscal policy is easy with a current 6% budget deficit.
That said, we see important risks to our baseline scenario that could lead to a substantial economic slowdown and alter the inflation outlook in the US. As of this writing, financial markets are placing the odds of a recession in 2025 at 25%, a declining but still meaningful chance.
Chief among these risks are:
• Ongoing geopolitical challenges around the world, such as the wars in Ukraine and the Middle East, and rising US trade tensions with China and other nations.
• The large and expanding size of the government deficits and overall debt in the US, which could force interest rates to stay higher for much longer, especially at the long end of the curve.
• A too-hasty easing of monetary policy and conditions by the Fed, which could re-ignite price pressures and push inflation back up again.
Market Update
Stocks slid -1% to begin the final week of 2024 trading. Profit-taking/weakness in leading tech growth names propelled the downside. That trend continued in the holiday-shortened Tuesday New Year’s Eve session. The Nasdaq fell another -0.9% Tuesday to close the powerhouse 2024 year on a down note. Stocks turned the corner into 2025 with another lackluster day. A decline in car sales from market heavyweight Tesla weighed on stocks leaving indexes fractionally off to begin the new year. Investors found their footing and the first positive day of 2025 in Friday’s trade though interest rates continued their upward thrust. A strong rebound in semiconductors led a broad-based move with all but one market sector rising. The Nasdaq rebounded 1.6%.
A strong Friday failed to offset weakness through the earlier part of the week leaving the S&P 500 down -0.51% for the week. The Nasdaq 100 (QQQ) was off -0.76% though small cap stocks bucked the downdraft with a +0.92% rise this week.
Warm wishes and until next week.