Happy new year! I hope that you had a wonderful holiday season and are excited for the year ahead.

2024 was an exceptional year for markets and investors. As you review your year-end statements, you should undoubtedly be pleased with the progress you have made towards your longer-run financial goals. The broader US equity market (as measured by the S&P 500) rose 25.02% – far above historical averages.

In line with human nature and more specifically, investor behavior, the celebration of 2024 has been very brief and the rhetoric has immediately moved on to “what comes next?” and in many cases “what is going to go wrong?” The concern for markets as we head into 2025 seem to be centered on a few key themes: current valuations of markets, US growth prospects, the weakness into end the year (in December, the S&P 500 fell 2.4%), ongoing fear of inflation resurgence, and the sharp rise in interest rates (the 10 year US treasury rate now sits at 4.69%, up from 4.2% at start of December).

As a means of sharing our outlook for 2025, let’s address each of these “elephants in the room” in turn and see if we can’t enter 2025 with some degree of optimism!

Valuations – Many market commentors like to say that today’s equity markets are “expensive.” Some of that comes from indexes sitting at or near their highs (the result of two years of 20%+ returns). And some of that is based on current price to earnings multiples. The current p/e multiple (using estimated 2025 earnings) is ~22x for the S&P 500. While this is high by historical standards, it is by no means out of bounds given the corresponding backdrop. And if the US economy continues to grow (see next), there is chance that multiple declines (as earnings would come in higher, bringing the multiple down all else equal). Further, multiples do not tend to be the best predictor of returns in the short term but rather a better indicator of sentiment.

US economy – Markets thrive on certainty and with the ushering in of a new administration in the coming weeks, there is not a lot of clarity at this time. Trump campaigned on a variety of issues (lower taxes, tariffs, immigration changes, etc) that may have considerable economic impact – if they actually come to fruition. With Trump being a one-term/lame duck President and a very close party divide in both chambers of Congress, it is not a certainty that legislation promised during the campaign will pass.

Despite this uncertainty, the US economy remains in good shape. Growth is likely to slow (from elevated levels) but remain meaningfully positive (estimates we see call for a nominal rate of 4-5%) And with the US’ efforts over the past two decades to become more self reliant, there is not as much reliance on trade should that dynamic become challenged by Trump’s policies. It’s likely “US exceptionalism” will persist which should benefit US growth and equity prices. Forces such as AI should lead to further productivity gains and ongoing strength in the US consumer (especially amongst the higher income/higher spenders) is another important tailwind. Lastly, lower regulation and increased focused on deal flow and M&A will be supportive of US equity markets.

December weakness – If you were monitoring markets instead of Santa, you may have noticed some weakness in the final days of 2024. Major indices sold down for the month (yet quarterly returns remained positive). While companies and markets march right along even as the calendar turns to a new year, there is some seasonality and mechanical items to be aware of, including year-end rebalancing, tax loss harvesting, liquidations for tax payments, etc. to be aware of. We don’t see the December weakness as a foreboding sign in and of itself.

Inflation resurgence – inflation has come down meaningfully during the past year and is approaching the Fed’s 2% target. One of the main drivers (housing) has rolled over and is showing signs of moderation which is very encouraging. And yet, inflation has re-entered the discussion. Much of the concern regarding a potential resurgence in inflation appears to be related to the incoming administration and the uncertainty surrounding tariffs (which would raise prices) and immigration (which could add strain to labor markets and lead to higher wages). The latest FOMC meeting minutes showed the Fed is very focused on trade policy and tariffs, citing that as a reason to keep inflation estimates in line with 2024 levels. While we appreciate the concerns and can certainly connect the dots between policy and inflation, it’s important to consider all elements of the equation. A strong deceleration in other “sticky” areas like housing and autos should not be ignored. We anticipate inflation to continue to moderate – just not in a straight line.

Interest Rates – it is not always obvious to determine what is causing a rise in rates. The latest thinking is that it is largely due to renewed concerns over inflation (discussed above). If the Fed remains concerned about inflation, it will likely take a more cautious approach to cutting rates than had been anticipated at the start of 2024. Unless the labor market weakens significantly, the path for the Fed rate cuts is likely to be slower and shallower than previously expected. However, we still anticipate rates to come down from current levels as more certainty is provided on the administration’s policies and inflation data continues to be available. Rates falling from current levels is supportive of not only fixed income but also equities and remains our base case (although the timing is uncertain)

Putting all of the above together, our outlook for 2025 in three words is: encouraging, normalized, and non-linear.

Encouraging – Growth continues, inflation moderates, earnings and US productivity continue to grow. And with a recent downshift in sentiment (ie: less bullish market participants), entry points look more attractive than they did a few months ago

Normalized – While we don’t necessarily see another 20%+ return, it’s not out of bounds to anticipate a normalized rate of return from US equity markets, as well as fixed income markets given the current backdrop

Non-Linear – Without a doubt, this will be a volatile year on many levels. With that uncertainty and potential market-moving events, we anticipate a very non-linear trajectory for all asset classes. For long-term investors, this is just background noise. But for more tactical investors, non-linear movements present opportunities so stay ready!

I’ll leave you with one last intersting takeway from a research report this week, take it for what it’s worth.

There is an interesting fact pattern regarding the correlation between the US equity market’s annual return and and the return experienced during the first 5 trading days. If the market closes higher after 5 days (after being up at least 10% in the prior year), since 1950, the market has risen for the year 82% of the time (with an average return of 13%). If you believe in history repeating itself, you will be happy to know the US equity market did manage to close with a gain after the first five days in 2025!

Onward we go,