Q1 2025 Market & Economic Outlook

 

Current Economic Views

In 2024, the U.S. economy grew steadily as inflation and interest rates declined. Job growth was roughly 180,000 a month, which drove strong consumer spending. The U.S. Gross Domestic Product (GDP) grew by almost 3%, led by the resilient consumer.

 

The Consumer Price Index (CPI), a key inflation metric, continued to fall from the June 2022 peak of 9.1%. Inflation started in 2024 at 3.4% and dropped to 2.8% most recently, so progress has been uneven.

 

While inflation remains above the Federal Reserve’s target, the Fed has begun normalizing interest rates. The Fed lowered rates by 1% in 2024. Further rate cuts will likely depend on inflation progress.

 

The unemployment rate ended the year at 4.2%, which is low. Job growth slowed throughout 2024 compared to 2023. Strong job gains occurred in the government and health care industries, while gains in more cyclical industries (manufacturing, for example) slowed. Wage growth has remained sticky at about 4% on a year-over-year basis. With CPI at 2.8%, the average worker has felt a “real wage” growth of 1.2%. Inflation close to 2% has been consistent with wage growth closer to 3.5%.

 

At the December meeting, the Fed increased its year-end inflation projection to 2.5% from 2.1%. Also, the Fed reduced its estimated number of rate cuts in 2025 to two from four. GDP growth is now projected to be 2.1% in 2025 and 2% in 2026.

 

The U.S. remained a bright spot for global growth. Growth in Europe has stagnated despite record-low unemployment. China has announced multiple forms of fiscal stimulus to reach 5% growth, but its economy has remained sluggish due to its excessive property debt.

Looking ahead

We expect economic growth to continue, although 2025 will include some policy uncertainty. Global growth estimates for 2025 and 2026 appear steady at 3.1%, with the U.S. near 2%. Also, Bloomberg pegs the probability of a near-term U.S. recession at 20%, which is low.

 

U.S. Job growth is projected to continue, as there remain more job openings than unemployed individuals looking for work. Given multi-year gains in home and equity prices, household net worth remains at an all-time record. Healthy balance sheets and ongoing job growth point to further consumer spending resiliency.

 

Given policy uncertainty, we are taking a “to be determined” approach regarding the path of inflation and interest rates. Inflation levels can continue to trend lower, given the improvements in supply chains and the rise in housing costs potentially slowing.

 

President Trump campaigned on boosting economic growth through lower taxes and less regulation. However, passing legislation takes time and could be a challenge given the small Republican majorities in Congress. Some in Congress are concerned about raising the nation’s debt. Given the potential tariffs proposed (on adversaries and allies), trade policy is another uncertainty.

 

If inflation remains sticky, the Fed may have less flexibility to further lower rates.

Current Investment Views: Equities

The S&P 500 increased roughly 23% in 2024 and about 25% on a total return basis. This made 2024 the second consecutive year with a 20%-plus increase, the first time that has happened since 1998. Also, the Nasdaq was up roughly 28% last year.

 

Last year started with excitement around tech and artificial intelligence. As inflation growth slowed, the focus moved to lower interest rates, and then the year concluded with the GOP sweep.

 

Equities continued to trend higher in 2024’s fourth quarter, with the S&P 500 producing a 2.41% total return. Although the upward trajectory remains in place, equity markets finished the year slightly off the early December highs.

 

The advance marks the fifth consecutive quarter of index price appreciation.

 

Although small-cap stocks outperformed in November following the election results, most of that outperformance unwound in December, and small-caps ended up underperforming large-cap stocks yet again.  Large-cap growth stocks were among the best-performing in the fourth quarter – a common theme throughout 2023 and 2024.

 

Multiple expansions drove equity market returns in 2024, however we view that as unlikely to continue given today’s historically elevated levels. We suspect this means equity market performance will have to be supported by earnings growth. The good news is that consensus estimates forecast 14.8% earnings growth year over year for 2025. Stocks can continue to perform well even without further multiple expansions.

Looking ahead

Wall Street’s S&P 500 2025 year-end price targets range from 6,500 to 7,100. That would be roughly 10% to 20% above where we are now. Also, expectations call for a broadening beyond mega-cap tech stocks. Essentially, we expect to see growth driven by more than just what we have seen in the past couple of years. 

 

Most data heading into 2025 looks solid to strong. The U.S. consumer is still in good shape, so spending is expected to continue.

 

Overall, there seems to be cautious optimism because of the potential for U.S. business deregulation.

 

Once again, the U.S. has better earnings growth expectations than the rest of the world. Inflation is generally seen as contained globally, though not vanquished. AI is expected to be a key theme and a major driver of capital expenditures this year.

 

The incoming administration is a topic we will be watching closely in 2025 as pro-growth policies (deregulation and lower corporate taxes) are balanced against inflationary policies (immigration and tariffs). 

 

Depending on how much the administration can accomplish will likely sway the outlook for growth and inflation.

Current Investment Views: Fixed Income

Although the Federal Reserve cut interest rates by 100 basis points last year, Treasury coupon curve returns were uneventful. The 2-Year U.S. Treasury, particularly sensitive to monetary policy, ended 2024 at 4.24%, less than one basis point away from where it began the year. The 10-Year U.S. Treasury rose 69 basis points, ending at 4.57%. Reasons for the upward momentum in longer-term yields in 2024 include:

 

• The U.S. economy continued to expand at a solid pace. Real GDP grew significantly outside of the first quarter. The labor market remained strong, and recession fears were brief. Officials noted that the neutral rate (when rates neither restrict nor stimulate the economy) may be significantly higher than before the pandemic.
• Inflation worries resurfaced as data showed an uptick in prices above the Fed’s 2% target. Core PCE inflation, the Fed’s preferred gauge, stood at 2.8% year over year recently, showing no real progress to target since May.
• The Republican sweep generated uncertainty and nervous sentiment about the potential enactment of President Trump’s proposed policies, which are considered stimulative and inflationary.

 

Credit spreads (the excess yield investors demand for holding a corporate bond instead of a similar Treasury) ground to historical tights. The average U.S. Investment Grade spread finished the year down 22 basis points to 82 basis points, while the average U.S. High Yield spread shrunk 47 basis points to 292 basis points.

 

Overall, the fixed-income market was repeatedly surprised by the resilience of the U.S. economy. Inflation worries also reemerged, and the incoming administration’s proposed policies produced uncertainty, all leading to higher intermediate- and long-term yields.

Looking ahead

In the Fed’s latest economic projections, the median unemployment rate for the end of 2025 decreased to 4.3% from 4.4% to reflect the recent labor market stabilization. The Fed’s median core PCE inflation projection for the end of 2025 increased to 2.5% from 2.2%.

 

Given the Fed’s recent commentary on the lack of further disinflation progress and the uncertain economic outlook, the Fed’s median projection for four quarter-point cuts in 2025 dropped to only two. The 2026 and 2027 median projections moved higher in conjunction with less easing in the near term. Fed members generally expect a slow and steady easing cycle.

 

The path for future rate cuts remains uncertain. Disinflation has slowed recently, but the labor market has shown signs of softening. Significant fiscal policy changes, the growing national debt, and international conflicts add to the uncertainty. Estimates of the neutral rate still vary, although the consensus has moved upward in the past half-year.

 

We still think we are in a soft/no landing scenario, but a slight slowdown remains possible. Layoffs are still rare, but hiring has substantially slowed. The fixed income story in 2025 will largely be centered around how much easing the Fed will do, considering the evolution of inflation and the labor market.

Asset Spotlight: Fewer public listings

If the stock market is a buffet, the options are becoming slimmer. According to the World Bank, there are 3,500 fewer U.S.-based publicly listed companies than at the peak of the dot-com era (a roughly 50% decline). What is more, a large portion of the remaining companies — especially among small-caps — are unprofitable.

 

The initial public offering (IPO) pipeline is slowing for various reasons.

 

For one thing, going public is expensive. Companies face significant underwriting, legal, and accounting fees when preparing for an IPO and other registration costs. A 2017 report from PricewaterhouseCoopers says that the average costs to go public are around $22 million for a company with $250-500 million in revenue. Not only are IPOs expensive, but simply being a public company itself introduces new overhead expenses and regulatory risk.

 

Additionally, private market financing is abundant today, thanks to the growth of private equity and credit markets. Institutional investors and wealthy families/individuals are looking to augment public market returns by often investing in private markets. As a result, companies can stay private for longer and on a larger scale. For example, ByteDance (the parent company of TikTok) is privately held and valued at around $300 billion, which is about the size of Salesforce Inc., one of the world’s largest software companies.

 

A third key driver behind the decline of IPOs is that start-up founders often sell instead of taking the company public. Large, profitable public companies with heaps of cash are acquiring private companies at a high rate these days, and that often represents a more attractive exit for start-up founders (and their investors) than the expensive and uncertain path to an IPO.

Looking ahead

Notably, about 3,500 public companies are still on U.S. exchanges, and those companies contribute more substantially to overall economic activity than ever before.

 

We may see a modest reversal in the declining number of public companies since the business environment is improving and President Trump favors deregulation.

 

The incoming Chair of the SEC, Paul Atkins, is known for his pro-business and laissez-faire leanings. If the burden of going public diminishes, more companies might opt for an IPO.

 

However, the tailwinds for companies to go public are likely limited. The desire to go public is weaker than prior decades. Those that have gone public and have weak prospects face additional challenges with financing becoming scarce.

 

Another issue worth watching is the weight the mega-tech companies now have in the stock market. Price swings among the largest public companies now impact the overall market to a much higher degree.

 

As fewer and fewer companies are traded publicly, another interesting trend has emerged. Private investment funds – once the exclusive investment domain of large institutions and the ultra-rich – have become more accessible to individual investors. Finding appropriate strategies and favorable terms is often tricky, so having an expert fiduciary advisor is critical.