New Year Market Update 2025: Looking Forward
New Year Market Update 2025: Looking Forward
At the beginning of last year, I wrote that 2023 will be remembered as a banner year. I could say the same for 2024. Markets rallied once again; however, this past year differs from 2023 in one important way.
The 2023 market performance was, by and large, a recovery of losses from 2022. What I mean is that markets were down so much in 2022 that all of the huge “gains” in 2023 were merely a reclaiming of the losses that occurred in 2022. The gains in 2024 are real gains, at least for now.
For most of 2024, the market gains were very broad and quite substantial; however, the fourth quarter showed particular deference to U.S. Large-cap stocks. The S&P 500 and Nasdaq rallied while small caps and bonds struggled to find any positive momentum. Meanwhile, international stocks posted large losses in Q4.
It is my belief that the themes and trends of Q4 give us a peak into the market psychology of 2025. There were three big major factors that arose in Q4 that will continue to be the driving factor for 2025.
- Policy on regulations and tariffs.
- Inflation “stickiness”.
- Interest rate cuts.
I think addressing these items is more important than rehashing 2024 in extreme detail.
We, of course, will have a new administration in 2025, and there will be an emphasis on deregulation (which is, in general, good for stocks). However, there will also be an emphasis on correcting trade deficits, and the primary tool for the anticipated negotiations is the use of tariffs. I wrote extensively about this in the past, and in my view, the bark here is much more significant than the bite. I believe the tariff announcements will result in knee-jerk reactions in the market but ultimately will have a minimal impact on the value of companies (aka stocks) over any significant period of time. The anticipation of tariffs certainly contributed to the underperformance of international equities in Q4 and, in my view, may present an opportunity as that was likely an overreaction.
At the beginning of last year through the summer, we saw inflation finally begin to retreat, as you can see below.
As the third and fourth quarter began, however, inflation remained stubbornly high. This bleeds over into issue number 3 (interest rates). The Fed is attempting to combat inflation, and when inflation retreats, the probability of interest rate cuts increases. However, when inflation remains high, the interest rate market responds by rising (regardless of whether or not the Fed cut rates recently).
Below, you will see that the 2 and 5-year treasury rates experienced a pretty dramatic increase at the beginning of Q4.
Higher interest rates are not great for the market overall, but they have a more pronounced impact on international stocks, bonds, and small-cap stocks. This speaks volumes as to the reason behind performance discrepancies in asset classes throughout Q4.
To summarize, in 2025, we anticipate that tariffs will have a short-term impact on markets and that the real driver of markets will be inflation and interest rates. If inflation tempers and the Fed cuts interest rates throughout the year, markets will rally. If inflation remains steady, the Fed will likely hold rates causing some market stagnation. In that scenario, it is likely that President Trump will put some pressure on the Fed to cut rates. It remains to be seen whether that pressure will be a factor. Overall, we’re optimistic for the coming year and excited to see what unfolds.
Written by: Brice Carter
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