2025 Forecast: Inflation Risk Tempers Outlook For 3-Year-Old Bull
In reviewing my 2024 forecast I feel like I did well. For 2024 I felt the bull market would continue with “More New All-Time Highs Anticipated,” and the potential for above average gains of 15-25%. I thought economic growth would slow and employment metrics would soften, but that it would remain healthy and that we would avoid a recession. I also felt the Fed had the potential to navigate a soft landing. If anything, I underestimated the strength of year 2 of the bull market.
With only a few trading days left in 2024 the S&P 500 is up 23.0%. The NASDAQ is up 29.2%. The DOW is up 12.3% and Russell 2000 brings up the rear with 10.1% gain year-to-date. Lagging small caps is a concern and along with keeping a close eye on the “Santa Claus Rally” and “January Indicator Trifecta” as named by The Stock Trader’s Almanac I will also be looking for broader market participation from the small cap sector.
Inflation
The Fed gave the market the quarter point rate cut it was expecting but made a concerted effort to reset the market’s expectations for interest rate policy next year. The Fed is concerned about inflation as it should be. It’s encouraging to see them listening to and taking some cues from the bond market. This is how the Fed was designed to function, implementing guardrails on interest rates based on the bond market and economic data. The Fed is walking the market back from its unrealistic rate cut expectations. It’s a classic under promise/over deliver posture. The Fed has now admitted there is an issue with stubborn inflation, especially core inflation. Now that the Fed has made it clear that it will probably be cutting less with inflation warming, the market in my opinion is set up to be pleasantly surprised if inflation settles down again and the Fed is able to lower rates further and faster toward a more neutral rate in line with annual GDP growth.
“Santa Claus Rally” Still in Store
Last week’s knee-jerk reaction selloff let a little air out the 2024 bull market balloon, but this year’s returns are still within my Best Case Scenario for the year. Odds still suggest we are in store for a Santa Claus Rally and the continuation of the bull market. After the gains we have logged this year a bout of profit taking and a little fear is understandable and perhaps a healthy removal of some of the froth in the market and sentiment.
Post-Election Years & Trump 2.0
Despite the recent selloff the 4-Year Cycle and general market seasonality remain on track. The pullback has reverted the major indices back toward the mean. As we move into 2025, I suspect Trump 2.0 policies will be supportive of the market and business and likely stir the animal spirits. Tariffs are likely to be used as a negotiating tactic to get folks to the table quickly. We have seen some of this already by the many world leaders who have visited and communicated with President-elect Trump over the past several weeks. He will likely employ his traditional “art-of-the-deal” shock and awe style to get people to the table to work on problems expeditiously. But as history shows the midterm elections are usually tough on incumbents with their party prone to losing control of Congress – and the republican majorities in the next Congress are quite thin. So, he has about a two-year window to get his agenda implemented before the midterms. He is unlikely to pursue any policy that jeopardizes the prospects of ensuring he has a legacy of economic prosperity, a bull market and global stability. There will be successes and missteps and that will keep the market on its toes next year.
2025 Forecast
As I present my outlook for 2025 let’s remember not to overreact to the big selloff last week and the Fed resetting expectations. I believe the Fed walking back rate cut expectations is not such a bad idea. Ask yourself what has changed materially or economically since the Fed’s announcement. Not much other than a bout of near-term profit taking in the market before year end. Yes, it will be important for the market to resume its rally in short order and for December yearend seasonality to kick in as well as small caps to get out of their funk. It has been a huge year, and the market has come a long way over the past two years so some profit taking here is not unusual. The “January Indicator Trifecta”, which incorporates the “Santa Claus Rally”, the “First Five Days” and the “January Barometer” are likely to prove critical this year. As forecast by “The Stock Trader’s Almanac” here are 3 likely scenarios for 2025.
Base Case: 65% Probability – Bull market tacks on average market gains of 8-12% with pullbacks in Q1 and Q3. Choppy trading as the market navigates change in Washington and the Fed trying to balance inflationary forces with sustained economic growth and a stable labor market.
Best Case: 25% Probability – Trump administration proves effective with few missteps. Inflation remains contained and U.S. economy continues steady growth without overheating or stalling. Geopolitics cools. Goldilocks scenario. Above average gains or 12-20%.
Worst Case: 10% Probability – Old school weak Republican President post-election year performance. Trump administration and Republican Congress implement too many drastic measures. Inflation spikes, economy cools, rates higher for longer and stubborn global turmoil. Teetering on bear market recession territory. Flat to negative full-year performance with broad losses across most asset classes.
While I am concerned about inflation, valuations and the older weak post-election patterns, I believe the bull market will continue through 2025, though I think it will likely be a much bumpier ride than it has been the last two years.
*Source: The Stock Trader’s Almanac
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