Outlook for 2025: Mill Street Research does not make “official” calendar year forecasts as we always follow the evolving messages from our objective indicators throughout the year, but in response to client interest, below we share some of our views going into 2025.
The good news
The US economy has done remarkably well and has decent momentum going into the new year. Earnings for the S&P 500 are expected to continue to rise next year, while small-cap earnings are expected to do some catching up after a long period of underperformance even as analysts are still trimming estimates. Earnings growth outside the US is mostly weaker but still expected to be positive. If these trends were to play out, that would be a favorable outcome for risk assets.
Source: Mill Street Research, Factset
The Fed has already lowered rates materially, and the US private sector is not heavily leveraged and employment and wage growth is slowing somewhat but still quite supportive. The Fed and other central banks will likely continue to lower policy rates in 2025, as growth outside the US remains relatively weak and US growth and inflation leave room for lower US rates.
Source: Mill Street Research, Factset
The US dollar will likely remain appealing relative to most other currencies (rates will fall more slowly in the US than elsewhere), and commodity prices seem more likely to be flat to lower rather than show sustained increases (barring dramatic new trade barriers).
Source: Mill Street Research, Bloomberg
Productivity growth has been strong recently in the US, and full employment along with technology are key drivers of productivity growth.
Source: Mill Street Research, Factset
Concerns about “excessive government debt” at the US federal level are entirely misguided. When compared to the value of private sector assets, or the growth of productivity and population, the US federal deficit and debt are not a concern, and there is no risk of “government insolvency” or “investors refusing to buy our debt”.
Source: Mill Street Research, Factset, Bloomberg
“What could go wrong?”
Too much focus on monetary policy and inflation, not enough on fiscal and regulatory policy
Inflation and Fed policy will not be the critical factors, unless inflation is caused by “shock” policy changes like large widespread tariffs. Monetary policy (lower rates) likely will not be able to produce better growth by itself – fiscal and regulatory policy, along with productivity growth, is needed to do that.
We are not concerned about inflation in general (excluding potential tariffs) because we view inflation mostly as driven by supply shocks rather than “excess demand”, so only new large supply shocks would cause more inflation. Inflation rose and has been falling globally across many countries since COVID and the invasion of Ukraine (two big supply shocks), and our view is that inflation will continue to moderate over time but the data still has noticeable lags and noise in it.
Source: Mill Street Research, Factset
Economic growth outside the US is mostly relatively weak, and thus not a source of inflation. Europe, UK, and China face continued structural headwinds to their economies, and political turmoil (Europe) or dysfunction (China) will make it hard to address those issues.
Indeed, the weakness in the economies of Europe/UK and China, as well as some other smaller economies, mean that the US (again) must be the main source of global growth and there is no “excess demand” globally.
New US administration brings policy uncertainty alongside valuation risks
Fiscal and regulatory policy mistakes are the most likely source of risk in 2025 in our view, along with equity valuations/sentiment to some degree. Investor optimism is relatively high right now.
Raising rates, or avoiding cutting them, in response to tariff-driven inflation changes would be a mistake, and one the Fed (and other central banks) will hopefully avoid.
Aggressive attempts to reduce the US federal deficit via spending cuts would be harmful to the economy, and large widespread tariffs would be a major headwind for both the US and global economy if enacted. Major US trading partners (most of which are allies) are already raising alarms and considering responses if there are major new tariffs on US imports (which could easily include many products which are not and could not be made in the US).
More corporate tax cuts will not help the economy much at all, and would have only modest effects on corporate profits given that the effective corporate tax rate is already quite low (and smaller companies with little or no profits will not benefit). Some of the earlier Trump tax cuts (Tax Cut and Jobs Act from 2018) are due to expire in 2025, but could be extended, though more tax cuts for individuals beyond that are unlikely and largely unneeded given the US economy’s current performance and the current federal deficit level.
Immigration policy is potentially more crucial, as any large-scale deportation attempts, or drastic reduction of immigration, would be a negative for many parts of the US economy. There remains great uncertainty on immigration policy, but many economists and the Fed have noted the net benefit to the US economy from immigration in recent years.
From a market standpoint, excessive investor optimism is the other potential worry as we go into 2025. Surveys show investor sentiment is relatively high right now, and signs of “exuberance” in some parts of the market are visible, though not to the extremes seen in early 2021 thus far.
Source: Mill Street Research, Investors Intelligence, Consensus Inc.
Valuations for equities, especially US large-caps, are significantly higher now, and real bond yields now offer more competition for investors. In our stock/bond valuation framework, we estimate the level of long-run real earnings growth needed to justify current stock prices given normalized earnings, bond yields, inflation, and the economic backdrop. That “implied growth” estimate has risen sharply, and while not extreme relative to the actual historical growth rate of earnings, it does mean expectations are much higher now and thus the risk of disappointment from weaker-than-expected growth has risen. So “growth scares” whenever data comes in below expectations are more likely in 2025.
Source: Mill Street Research, Factset, Bloomberg
Among US sectors, we enter 2025 overweight in Communication Services, Financials, Technology, and Utilities. We remain underweight in Energy, Materials, and Industrials. Our positive view on Financials, as well as our cautious view on commodities extend globally, particularly in light of China’s continued weakness and sluggish manufacturing in Europe (esp. Germany), and the slow but ongoing shift toward renewable energy sources globally.
We continue to favor developed over emerging markets, and the US and developed Asia over Europe/UK within developed markets. Relative earnings trends continue to show US earnings dramatically outpacing those of ex-US markets in aggregate.
Source: Mill Street Research, Factset
As always, we will continue to follow our objective indicators as they evolve over time, and avoid constructing investment narratives based on headlines or simplistic assumptions. Knowing what not to worry about can add significant value to an investment process, as it reduces the analytical burden (not analyzing things that don’t really matter, i.e., “addition by subtraction”) and avoids panicking in response to things not worth panicking over (or conversely, getting overly excited about things that are not that impactful).
Professional investors of all types who are interested in Mill Street’s institutional research offering (which includes much more on the topics discussed here, as well as global stock selection) are encouraged to reach out to info@millstreetresearch.com for more information.
We wish everyone the best for a happy and healthy 2025!