Prospects for the Economy and Financial Markets in 2025
The Mt. Shasta guide team my climbing buddy and I hired to get certified in Crevasse Rescue in 2011 were the strongest young climbers we’ve ever seen, but over the five-day expedition three separate misjudgments of both terrain and technical strategy unnecessarily placed us in immediate life-threatening danger, harrowing ordeals still scary to think about today. The decisions were so bad that with only modest mountaineering experience we were able to identify each miscalculation, only to be overruled by the authority of the head guide. There is undoubtedly widespread confusion today over the 2025 U.S. economic and financial outlook due to recent ‘Fed’ misjudgments, in particular with trends in inflation, earnings, and interest rates. What is the true condition set for the economy and stock market, which direction does each pursue, and what is the potential range of outcomes?
‘The Fed’ has been promoting a narrative that lower rates will bring the economy to a soft landing in controlled inflation, but the economy isn’t slowing, it doesn’t need lower rates, and inflation isn’t contained. S&P 500 businesses have seen 8% average earnings growth in the last decade, only 7% annually long-term, and yet the forecast for 2025 is 9.5%.¹ Fidelity sees 14% earnings growth ahead and thinks the estimate is too low!² Tuesday’s employment report shattered estimates, revealing 256,000 new jobs were created in December and dropping unemployment to 4.1%.³ Let’s understand these simple facts about the economy today:
There is no indication of an oncoming recession anywhere on the horizon as far as the eye can see, though another increase in bankruptcies is possible in this new higher rate era.
Interest rates are probably net neutral at best in this economy (meaning, about right or too low).
Absent a recession, the probability of a significant bear market is low, and risk of a systemic crisis is even lower.
A strong economy is constructive for business investment.
The stock market is far less correlated to the true condition of the economy than most investors realize. The market looks forward to future earnings, while a recession is identified only in hindsight; also, economic reporters are bankers and politicians who never admit to a recession until it’s over. Let’s think about relevant market factors and the two most probable outcomes for a frothy market with a strong economy underneath it:
22 times earnings places the S&P 500 into the top decile of observations,⁴ making it the top concern for stocks in 2025. By my count the S&P 500 could drop 23% just to get to its average long-term multiple, all other things being equal, and the market seldom lingers amongst its averages.
Higher valuations always lead to lower forward returns, and vice versa. A study of people who paid today’s rare multiple for the S&P 500 over a 27-year period universally earned ten-year average returns between -2% and 2%.⁵
A new administration with new policies, especially when tariffs are involved, will probably add to the increased volatility generally associated with an expensive market.
The two most probable outcomes I see, in this order, are a) a volatile market moves sideways or even down in 2025, allowing corporate earnings to catch up to prices and lowering multiples while avoiding a bear market and setting the stage for more sustainable growth, or b) a blow-off top, in what would be a third consecutive year of huge gains, but ending in a significant and protracted bear market bust that would likely take the economy with it.
Focus on quality and look for value and income. Diversify, but don’t risk the cash you may need for expenses or emergencies in the next five years. Ride the bull for its duration but have your “risk off” plan in place and honor it.
Think about it, Shaun.
“It’s not what you buy, it’s what you pay that counts. Good investing doesn’t come from buying good things, but from buying things well. There’s no asset so good that it can’t become overpriced, and thus dangerous, and few assets so bad that they can’t get cheap enough to be a bargain.” ~Howard Marks
“Be shrewd as a serpent, yet innocent as a dove” ~Matthew 10:16
1 Google, “Average S&P 500 Earnings 2024”, December 17, 2024 2 FPA (Financial Planning Association) Live Lunch Presentation, Iron Works, Warwick, RI, January 8, 2025, Fidelity Investments 2025 Outlook 3 MarketWatch, “Jobs report shows big 256,000 increase in December. Unemployment drops to 4.1%”, January 11, 2025 4,5 Oaktree Capital Management, Howard Marks’ Memo, “On Bubble Watch”, January, 2025
The opinions voiced in this material are general and are not intended to provide specific recommendations.
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