January 2025 Update on the Economy and Investment Markets

Welcome to the Stearns New Year’s Investment commentary.  As we contemplate the year ahead, we want first to wish our clients a healthy and prosperous New Year!  We have much to be grateful for and much to consider as we move into 2025.   

As always, we stand ready to help you solve financial and non-financial problems, both big and small, while maintaining a steady hand and watchful eye on your investments. Toward the bottom of this commentary, you will find our best thinking on our Four Key Themes for 2025.   

Let’s first start with the Economic Updates since we last went to press: 

⮚ The post-election “Trump-Bump” in stocks fizzled out as quickly as it started, with Monday’s S&P 500 valuation coming in close to the pre-election high. The reversal was triggered by the Fed’s signal in December that fewer interest rate cuts are coming in 2025 due to “new Trump administration policy uncertainty.” Investors are also focused on the debate over whether stretched U.S. stock valuations are sustainable given uncertainty around 2025 profit growth despite a pro-growth Trumponomics environment that includes potential anti-growth tariff headwinds. 

Important reminder – when Trump was first elected in 2016, the U.S. stock market was at a reasonable 16X earnings valuation, which happens to roughly equal the historic average. This time around, however, the market is at 22X, meaning it is, “priced for perfection.” Given current valuations, any surprise economic news can create volatility in the markets. See further below for our outlook on U.S. stocks. 

⮚ The U.S. Federal Reserve cut interest rates by 0.25% in December as they continued to pursue a “soft landing” (i.e. no recession) for the U.S. economy. The result of a total 1% reduction in short term interest rates the past several months is that we now have a less restrictive economic policy. Investors will be keenly focused on the Fed’s evaluation of inflation in 2025 given inflationary pressures that may result from some of Trump’s proposed strategies, particularly tariffs, but also immigration reform.  

⮚ The latest inflation data on Personal Consumption Expenditures (PCE) (The Fed’s favorite inflation index since it tracks how consumers actually spend money) showed a 2.4% rise in November on an annual basis, just below the 2.5% estimate of economists polled by Reuters. This means inflation is trending in a better direction despite an earlier CPI report showing an uptick. The one-month measures were weaker than the three-month measures and both were weaker than the 12-month measures. 

Based on this, perhaps the stock market didn’t need to have its panic attack in December. Two key measures of inflation, CPI and PCE, driven by the same underlying data, told different stories in December, due only to their differing weighting schemes.  As mentioned above, when valuations are high, any economic news can swing the pendulum quickly. 

⮚ The U.S. GDP economic forecast was upgraded for the fourth quarter of 2024 and for the entirety of 2025 by the Federal Reserve. At the same time, several of SFG’s key research sources suggested that consumers may be losing steam in their buying spree sometime during 2025.  

⮚ Geopolitics: SFG has typically ignored geo-politics in our calculus of investment strategies given such events impact markets only for short periods of time. Even so, we are ever mindful of geopolitical events and their potential impact. At this time, we are focused on three disparate issues, two of which may be mitigated by Trump policies: 

Four Key Themes for 2025 

1. Trumponomics creates both headwinds and tailwinds for U.S. stocks – the favorable tailwinds are fairly straightforward. Deregulation (which helps profits), a pro-growth philosophy and potentially lower corporate taxes are all helpful to justify higher stock prices.  

The unfavorable headwinds for select U.S. stocks include tariffs – we believe actual tariffs implemented will be more modest than announced and will mimic Trump’s previous term. Given that Mexico is now the #1 trading partner of the U.S. (China is still #2), threatened tariffs against Mexico, if implemented, will create issues for many U.S. companies.  

While the more modest tariff impact is our #1 scenario, we note that many private and public businesses are still running deeper scenario analysis around more intense trade war possibilities.  

SFG’s Take: It may be that tailwinds and headwinds under Trumponomics will offset each other in 2025 and good old fashioned corporate earnings growth will be the primary determinant in U.S. stock growth. SFG has a number of risk balancing strategies in motion depending on the unique circumstances of each of our clients.  

2. Fed collides with Trumponomics – Chairman Powell’s recent statements and those of many key FOMC members suggest they are concerned Trumponomics may be inflationary. The Fed comments further indicate their belief the economy is “in a good place” with inflation pressures currently more balanced.  

Per Fed Chairman Powell: “We need to take our time with future rate cuts, not rush, and make a very careful assessment, but only when we’ve actually seen what the [Trump administration] policies are and how they’ve been implemented,” Powell said of the Trump plans. “We’re just not at that stage.” 

SFG’s Take: It is likely that inflation pressures will be mostly offset by disinflationary forces in 2025. Note that inflation risks on a five-year horizon are above average. It is wise to believe the Fed will only cut interest rates twice in 2025 and that we are not far away from the bottom of rate cuts in this economic cycle.   

If you’re waiting to refinance a HELOC or variable loan, you may get some relief within six months. Mortgage experts predict rates could ease .5 – 1% on 15- and 30-year mortgages. These rates rose after the election with concerns about inflation under Trumponomics 2.0. With all the other 2025 factors discussed, SFG rates this mortgage rate easing potential as a HIGH uncertainty level.  

3. The Musk X factor – we’ve already seen several major dustups in December between Senate Republicans and Elon Musk. More recently, the HB-1 immigration visa debate pitted core MAGA elements against Musk and other tech moguls. Meanwhile, the cover of Time magazine highlighted Musk’s goal to cut $2 trillion from the budget and work to stabilize the growing deficit. 

Musk and DOGE (Department of Government Efficiency) partner Vivek Ramaswamy intend to shake up the status quo and trim back the federal government size. New on the chopping block are elements of Medicare and Social Security.  

Musk & Co. are likely to accelerate tech productivity inside and outside the government. This is yet another X factor that could bring greater rewards in stocks and other investments.  

SFG’s Take: While Musk’s goal of cutting $2 trillion from the federal budget to reduce the deficit is still a possibility, and some measure of that would be healthy for getting federal debt under control, we believe that President Elect Trump and his advisors are not willing to risk tanking the economy (as happened in Argentina) by going to that extreme. However, the Musk X Factor remains a significant wildcard in our 2025 economic scenarios.  

4. Diversification Rules Again – As we saw in 2022, diversification the “SFG way” ruled the day by dampening severe volatility and allowing our retired clients to withdraw from their portfolios without selling “low.” The last two years have featured the Fabulous U.S. Stock Show, outperforming most other asset classes with occasional hair-raising rollercoaster dips.  

International stocks gave the U.S. a run for the money until the U.S. dollar strengthened (due to concern about inflation and interest rate upward pressures) after Trump won the election. Given the tailwinds and headwinds noted above, it’s hard to say if the outperforming U.S. stock show might continue. As the Goldman Sachs “Lost Decade” forecast and the Bank Credit Analyst forecast in the last Compass indicated, returns for U.S. stocks over the next 10 years are highly unlikely to equal those of the last decade based simply on elevated valuations.  

Warren Buffett’s large stock sales and his $325+ billion cash raise are not quite at 2004 record levels, but they do suggest the Berkshire team is concerned about valuations and has raised a war chest while awaiting better opportunities. This is an imperfect stock desirability indicator when looking forward 12 months, but per our friend Mark Hulbert of the Hulbert Financial Digest, Buffett’s current cash raise does suggest it may prudent to be considerably more cautious in U.S. stocks over a five-year time horizon.  

SFG’s Take: SFG will be keeping a keen eye on the earnings front (support for stretched stock valuations) and actual Trumponomics policies in 2025, which in turn may cause more surprise Fed moves. SFG generally raises cash to mitigate portfolio withdrawal risk and uses rebalancing (within asset classes and broadly) plus select alternatives to lower portfolio vulnerability to large swings in stocks. 

Longer Term Key Issue – Chart of the Month – while the growing global debt concern may not have a big impact in 2025 (unless Musk & Co. are given a longer leash to cut the budget), the pressures the debt causes have moved closer to a five-year planning horizon based on various forecasting models we respect.  

SFG Take: 2025 could be a pivotal year in the battle to slow the U.S. deficit and debt growth. SFG has developed several strategies to mitigate this risk in the near future if progress isn’t made on the deficit.