With the new administration having taken office, investors will be working hard to divine how the administration’s economic policies will affect their investments.  While there are many unknowns, one known fact is that the U.S. economy is in pretty good shape heading into 2025.  The unemployment rate is low at 3.5%, reflecting a tight labor market, while U.S. GDP growth in the latest quarter was 2.3%, a moderate rate of growth impacted by higher borrowing costs and slower economic growth around the world.  In general, investors seem to be optimistic that the new administration’s efforts to reduce regulations will ultimately benefit corporate earnings and increase mergers and acquisitions, but they are also wary of how new trade policies will impact companies.  Of the total revenue generated by the S&P 500 companies, roughly 29% is generated outside of the U.S.

Here are several themes that will impact markets in 2025:

Corporate Earnings

As we enter the new year, analysts are bullish on earnings growth for the S&P 500 companies.  The current estimate for S&P 500 earnings growth for 2025, according to FactSet, which aggregates estimates from many analysts, is 14%, followed by 13% estimated growth for 2026.  Historically speaking, these are very high numbers, and even though they will likely be watered down a bit as we get into the year, they reflect analysts’ strong optimism about the near-term prospects for corporate profits.

Tariffs

Tariffs are the centerpiece of the new administration’s trade policy, and frankly it is anybody’s guess as to how trade policy takes shape.  So far, investors seem to be expecting a less severe tariff regime than that which was espoused on the campaign trail.  Whatever the initial volley of tariffs looks like, we are expecting frequent and abrupt changes as deals get worked out individually with trading partners.  If we should get embroiled in drawn out trade wars with Mexico, Canada, China or others, equity markets will likely feel some pressure.  Restrictive tariffs, especially on important sectors such as technology, manufacturing, and agriculture, could disrupt supply chains, increase production costs, reduce corporate profitability and stoke inflation.

Tax Policy

The Tax Cuts and Jobs Act (TCJA), which became law in December 2017, is set to sunset at the end of 2025.  Congress will likely move to extend this policy and may also introduce some new tax legislation.  Given Republican control of Congress, investors can reasonably assume that there will be no momentous changes in the tax code for 2026.

Inflation

Perhaps the biggest threat to the equity markets in 2025 is the potential for the Federal Reserve to stop lowering interest rates on account of sticky inflation.  Through 2024, the anticipation of a lower Fed Funds rate, and then also an actual lower Fed Funds rate, helped to drive stocks to double-digit returns.  If inflation should hold stubbornly above the Fed’s 2% inflation target, however, the Fed may feel compelled to stop lowering rates.  The Consumer Price Index for December, released last Friday, was slightly lower than economists’ forecasts, but still showed that inflation is hovering in the high 2% range.  If the Fed decides it has lowered rates enough for the time being, we could see bond yields creep higher, perhaps pushing the U.S. 10-year Treasury note over 5%.  Stock investors would probably not like such a turn of events. 

Outlook for 2025

The new administration faces a high bar in the form of a somewhat expensive stock market and enthusiastic investors.  (Remember, the most robust returns usually originate from inexpensive markets with many gloomy investors.)  After two years of very strong returns, the next 20% may take a while.  Relative to last year, when stocks went mostly straight up except for a couple of short-lived hiccups in April and August, we expect 2025 to be quite a bit more volatile and have less overall upside than the previous two years.  We expect both short-term and long-term yields to remain in the vicinity of where they sit today, which we view as close to fair value for fixed income, given today’s growth and inflation outlooks.

As always, we welcome your comments and feedback.  Please contact us if there is anything you would like to discuss about your investments or the markets.

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