As we pull together our thoughts to synthesize the 2025 outlook for investors, it’s a bit like commuting in the Phoenix area. Public transportation here is virtually nil, so most people drive the grid made up of city streets and avenues, interspersed with the super structure loop freeways and meandering residential lanes. But we never seem to know where a new construction project is going to crop up and throw a predictable commute into an odyssey of guessing the shortest route. AndSaturdaysare often the worst.
Like car-bound commuters, one of the things markets love above all is certainty. And typically, at this time in a presidential election year as we look forward to the upcoming new calendar, there is an increased amount of certainty based on election results. This is not the case here at the end of 2024. As we try to quantify our projections, we are working with a mixed bag. There are four main factors to consider, two tailwinds and two headwinds.
Tailwind 1: Tax Cuts – we are likely to see an extension of the 2017 tax cuts or even a change to make them permanent. Another good possibility is lower corporate tax rates. Any combination of these policies will be a benefit to investors.
Tailwind 2: Deregulation – the incoming administration is keenly focused on eliminating red tape and onerous regulations on business, and the DOGE (Department of Government Efficiency) commission has been set up to look at cutting the related spending and costs. These efforts should translate into higher profits and a favorable environment for investment.
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Headwind 1: Tariffs – the incoming administration plans to use tariffs to reduce the US foreign trade deficit and offset some of the lost revenue from tax cuts. However, the use of tariffs can lead to retaliation and a decrease in trade and economic activity. Tariffs also act as a tax increase on consumers. Additionally, the revenue that might be raised is highly unpredictable. These are all negatives for the economy and investment.
Headwind 2: Immigration & Deportation – one of the biggest challenges for US businesses over the last decade has been a shortage of workers. In the last 4 years, that situation has improved largely thanks to a higher number of immigrants. The plans the incoming administration has announced to deport millions of workers and to restrict immigrants from coming in will be a big negative for economic growth and likely reverse the improving inflationary trends.
It is difficult to say with any certainty to what level any tariffs or deportations will be carried out. The imposition of tariffs could be a tactic to help in negotiations on other issues. And it is possible to think the deportation plans will only extend to those who have already been through a court proceeding and are on the way out anyway. If these actions are limited, the negative effects on the economy would probably be felt less. But at this point, we will have to wait and see and prepare for what could happen.
Stocks– our outlook for the stock market is fairly constructive, but we would caution that after two years of higher-than-average returns for the major indices, it would be highly unlikely to see a third year of outsize returns. Still, the economy is strong, the headwinds we outlined above are more likely than not to be put into place and, although valuations are stretched, we expect the markets could maintain forward motion, perhaps in the low to mid-single digits. And if the economy continues to power ahead, small and mid-caps could outperform the mega caps that have led the market the last two years.
Bonds– the negative headwinds outlined above all have an inflationary component. The path of inflation, not necessarily the absolute level, will determine what happens with bonds. And there are a number of other factors that could come into play. High levels of government debt will keep the Fed from addressing a rebound in inflation as aggressively as they might like. A continuation of shortening supply chains, from just-in-time to just-in-case inventory adjustments mean higher pricing along the entire chain. And the pressures from climate change events like hurricanes, fires and floods and a tight labor market compound the difficulties related to bond issuance and rates. It is likely that rates will have to be higher than what the Fed has outlined up until now as neutral. Could that mean rate hikes instead of continued easing? More uncertainty.
Alternatives– one of the main tools in any investor toolbox is diversification. Many investors stick solely to stocks and bonds and rebalance between the two as a simple way to diversify. The addition of alternative investments is another tool to consider. Commodities, hedged investments, real estate, precious metals, private credit and others can be added to a portfolio to provide further diversification. Why? There is a tradeoff. Alternatives are considered to be non-correlated investments. That means they tend to move opposite to stocks or bonds. They also can have higher costs in some cases and might not be right for every investor. But in times of uncertainty, they could provide some defense in volatile markets.
Finally, we should mention the unlikely obstacles that could crop up in our commute from the old year into the new. Geopolitical events can occur unexpectedly and can have widely unpredictable consequences for economies and investments. There are obvious hot spots like Ukraine, Gaza and Syria. These conflicts could spread and become much worse. But there could also be any number of other events, conflicts or surprises that would affect portfolios. These kinds of events are always possible but usually very unlikely.
Then there are things that could go right, unexpectedly, like a surprise peace negotiation or a scientific breakthrough that could affect millions with a particular disease or a technology solution like we are seeing with AI. We are always watching for these events as well, and often they don’t get a lot of press attention.
We would like to close by saying thank you. We appreciate the trust our clients have placed in us and it is our great honor to work on your behalf. We hope the new year brings health and happiness for you and all your loved ones.
Happy 2025!