Good things come in threes

Or, if you prefer the Latin, omne trium perfectum. Late-year stumble aside, the market has held up despite a Fed that expects to cut just twice this year. And why not? The economy is strong and not reliant on easy money from the central bank. There are all sorts of reasons this could continue. If, as we believe, the S&P 500 finishes this year at 7,000, that’ll be a 19% return, very respectable next to 2023 and 2024. The weeks ahead could be bumpy, as the market adjusts to a new administration after the honeymoon ends. Whatever. Earnings are the foundation of any sustainable rise, and they look set to advance solidly in 2025. Current projections are for an 8.5% increase; in strong economies, the surprise is typically to the upside. Meantime, inflation remains tethered (for now). Businesses expect unit costs to increase just 2% over the next 12 months. Goldman Sachs sees core PCE falling to 2.1% by December 2025, with tariffs not doing much to disrupt the decline. If so, the Fed will have room to cut as needed. In a soft landing, central banks are prone to wind up with the policy rate below neutral, particularly when unemployment is up, which suggests a Powell put of sorts. If unemployment can stay below 4.5% (and if the 10-year can do the same), this could be a good year for stocks. And we may see gains in China as well (notwithstanding recent days), after a very strong 2025 in dollar terms. China says it will issue special government bonds worth three trillion yuan ($411 billion), the most ever, in a bid to increase consumption in advance of expected Trump tariffs.

Still, a lot could go wrong this year. There’s an awful lot of bullishness—perhaps too much. The percentage of consumers who expect stocks to go up this year is near an all-time high. As for rates, 10-year Treasuries are close to 4.6%, having risen sharply this fall. If deficit worries finally take hold, the bond vigilantes might send it to 5%, which would be painful for equities. Net interest payments and entitlements have been eating up most of the federal government’s tax receipts lately, suggesting that any downturn could catch the government flat-footed. There is the uncertainty of a new administration, which is likely to enact substantial policy changes with regard to tariffs and deportation. Estimates of resulting inflation are all over the map. Trump proposes the potentially contradictory effects of tariffs and immigration policy on the one hand while pursuing productivity growth, deregulation and tax cuts on the other. One of the biggest wet blankets dampening the economy is housing. The residential real estate market is frozen due to high mortgage rates even as supply remains inadequate to meet demand. Housing is a known multiplier spurring other economic activity, but that will have to remain subdued until rates recede enough to spur buyers and sellers into action. Will that require rising unemployment and a recession? Finally, can the US continue to prosper while other economies (most notably Europe) are so weak?

With no recession on the horizon, 2025 should be a good year, even if the Santa rally failed us. January is historically a strong month for the market, and it tends to have more predictive value for the market than does December. Indeed, Fundstrat notes that since 1928, there were 10 instances in which the market was down at least 3 of the final 5 trading days. The following January on average was strong, with a median return of 3.6% and an 80% win ratio. For the year, median returns were 12.4% with an 80% win ratio. Nice odds! In the meantime, the S&P 500’s forward profit margin rose to a record 13.6% last month. Trump’s corporate tax cuts should add a half percentage point or more to that figure. Not particularly worried about inflation resurgence or recession for 2025, we remain bullish. This week on Bloomberg radio I discussed the wisdom of playing the long game. Recessions last on average just 10 months. Since the administration of President Carter, to mark whose passing the NYSE will be closed next Thursday, the S&P 500 has risen from less than 100 to 6,000. There were just six bear markets during that time. As for 2025, good things come in threes!

Positives

• Manufacturing eyes the elusive 50 The S&P Global US manufacturing PMI reading was revised up by 1.1 to 49.4 in the final December report, beating consensus, with output, new orders and employment all revised higher. Also, the Dallas Fed’s survey moved into positive for the first time since early 2022. Importantly, Dallas generally leads other regional Feds, suggesting more good news will follow.
• No recession on the horizon The Atlanta Fed’s GDPNow estimates that Q4 GDP will be 2.4%, a solid number consistent with ongoing, stable growth.
• Energy evidencing a strong economy US commercial crude inventories fell to a five-year seasonal low. US domestic consumption exceeded 20.2 million barrels per day even though it has been a mild winter. US exports of petroleum products are at a new high.

Negatives

• One of the biggest wet blankets Mortgage applications dropped 21.9% for the week ending December 27 from two weeks previously, despite a statistical adjustment for Christmas. Rates for 30-year mortgages stand at 6.9%.
• Construction spending stands still Construction spending remained unchanged m/m despite hopes of an increase. Private spending rose 0.1% on an uptick in residential spending, while public spending declined 0.1% as increases in public residential spending were more than offset by decreases in public nonresidential.
• Show me, China China’s market closed down nearly 3% to start the year, the steepest first-day drop there since 2016. Weak manufacturing data and the threat of an increase in tariffs were blamed for the decline.

What Else

Santa called in sick It was a terrific year, for sure, but it ended badly. Since at least 1952 when records for this are available, the S&P 500 had its worst showing from Christmas to year-end, falling 2.6%. This was the twelfth time in those years that it fell more than 1%. It was also the longest streak of down days to end a year since 1966.  

It was good to be Magnificent last year December 2024 saw a 2% decline in the S&P 500, but market breadth was so feeble it’s a wonder it wasn’t worse. The equal-weighted S&P 500 lagged the cap-weighted index by 4.5%, fourth worst since 1990. EAFE’s 22.8% underperformance was the third worst going back to 1970, while the Russell 2000’s 13.9% lag was the third worst since 1979.

New money In dollar terms, the S&P 500 outperformed the STOXX Europe 600 in 2024 by the most this century. The Magnificent 7 ($16.4 trillion) now have a higher market cap than Europe ($13.7 trillion). The oldest of the Mag 7, Microsoft, turns 50 this year.