With Inflation Down, Prospects Turn Positive
Global economic growth will likely pick up in 2025 as more central banks follow the US, China, and Europe in switching from anti-inflation to growth policies. US GDP, which had been expanding at about 3.0% in the second quarter, is expected to accelerate into 2025, supported by declining inflation, a supportive Federal Reserve cutting short-term interest rates, and continued labor market resilience. As improving confidence in the global and US economies rises and the probability of hard landing recessions recedes, stock markets around the world will advance. The coming US election will generate wildly diverse predictions on its impact on stock markets, but we do not think that either party will gain control of the presidency and both houses of congress which would be necessary to pass significant partisan legislation.
US Exceptionalism: The Economic Soft-Landing is in Sight
We expect the US economy will remain the driver of the global recovery. The key development will be a continued decline in inflation from its 2022 peak of 8.8% to the latest reading of 2.5%. In 2025, the CPI will fall to, and perhaps even below, the Federal Reserve’s target of 2.0%. The Fed shares our confidence in the inflation trend. In September, it reduced the Fed Funds rate by 50 bps and projected two additional cuts in 2024 as well as four more in 2025. We are encouraged by this outlook, especially because there had been, in fact, some weakening in the labor market. The unemployment rate had risen to 4.3% from a low of 3.4%, job openings and hiring were down, and continuing unemployment insurance claims were up. However, the September jobs report showed a surprisingly robust rebound, which strengthened our view that the soft-landing scenario is intact. We expect growth to remain in the 2%-3% range in late-2024, which may need to be adjusted down due to the tragic devastation of hurricanes Helene and Milton. GDP should resume its rise in 2025.
The Bull Turns Two: Can US Stocks Continue Their Rally?
Our favorable outlook for US stocks in 2025 is based primarily on our forecast for a gain of 15%-18% in S&P 500 Index corporate profits. This is slightly above the consensus of 15.1% for next year. For the remainder of 2024, earnings from the S&P 500 are expected to increase 4.6% in the 3rd quarter, with a swift acceleration to 14.9% in the 4th quarter. The valuation of the S&P 500 Index is high (21.6x forward earnings), but not excessive, and should permit the index to rise in line with earnings. A double-digit gain in profits would justify elevated multiples and should buttress market confidence. It is reasonable to expect such an outcome in bottom lines as productivity has been rising, consumer spending remains resilient, and we enter a phase of gradual rate cuts. Investors should keep in mind the time-honored adage, “Don’t fight the Fed.”
In past Outlooks, we emphasized the leadership position within the S&P 500 Index of technology stocks in general and megacap stocks in particular. During the 3rd quarter, there was a noteworthy reversal: the S&P 500 cap-weighted advanced 5.5%, but the S&P 500 equal-weighted soared 9.1%, whereas the technology-heavy Nasdaq Composite was up only 2.6%. We view this market rotation as a positive development; from an historical perspective, markets which rely excessively on a very narrow leadership have proven vulnerable to abrupt declines.
Another positive development for US stocks is the mountain of money that has flowed into money market funds over the past 4 years. In September, these funds have mushroomed to over $6 trillion, whereas in the decade prior to the rise in inflation and the Fed’s policy of raising short-term rates, they were stable at about $3 trillion. Money market funds are attractive when they provide an interest rate of near or above 5% compared to less than 1% rates which prevailed in the years prior to 2020. They also provide a safe haven when the risk of recession is elevated. Now that the Fed is reducing rates, and the likelihood of economic hard landing is diminished, investors can be expected to shift funds to more growth-oriented securities, including common stocks.
Global Synchronized Stimulus: A New Growth Era?
While the US sustains economic growth, an inflection point may be emerging for the global economy. Major central banks around the world are pivoting away from restrictive policies to combat high inflation and embracing more pro-growth initiatives. The European Central Bank and the People’s Bank of China have already moved to reduce rates, joining the Federal Reserve in signaling a shift toward a more accommodative stance. We expect more synchronized interest rate cuts in the coming year. These actions will provide the fuel needed for accelerating global GDP growth to above 4.2% in 2025, a jump from this year’s modest 3.2%. The improved economic backdrop is likely to support increased business investment and strong consumer spending. Nevertheless, it is important to acknowledge the risks. Geopolitical tensions, particularly in Ukraine, Taiwan, and the Middle East, and potential disruptions to international trade are potential threats to our positive economic forecast.
Unlocking Value: The Potential of International Equities
International equities should benefit substantially from the transition to more accommodative monetary policies and a renewed focus on growth. While international stock markets have underperformed their US counterparts for several years, improving GDP prospects could trigger a reversal of this trend. A rise in global growth is a more meaningful change for international markets than the US, which has been insulated from the slowdown that the rest of the world has experienced in the past few years. Investors may soon view the combination of low valuations and an improving economic environment as a compelling opportunity. We think a selective approach that targets companies with strong fundamentals and limits exposure to geopolitical risks continues to be important if one looks to capitalize on international investment opportunities.
Back to Low Yields? Positioning for a Changing Rate Regime
We expect interest rates to decline over the next year, particularly at the short end of the yield curve as the Fed continues its rate-cutting cycle. We think that there is an underrated risk that we could return to the pre-COVID era of persistently low yields and suppressed returns across fixed income markets. If this scenario materializes, the current rate environment represents an opportunity to lock in value before the cycle turns. Investors may consider lengthening duration now to capture current yields, but this should be viewed as a moderate shift within a portfolio’s fixed income allocation rather than a change to the overall commitment to bonds.