Let me apologize in advance. This is the year-end column, the one that’s supposed to deliver bold, startling forecasts for the 12 months ahead.
That won’t be happening here this year, and for obvious reasons. If the recent past proves anything, it’s that many of our standard forecasting tools are broken.
That recession that Wall Street was braced for in 2023? Didn’t happen.
That widely expected move away from big tech stocks in 2024? Still waiting.
That steady fall in interest rates that many analysts had counted on for 2025? Increasingly in doubt.
The simple explanation for these forecasting failures is that the world has entered some very odd economic territory. Lingering effects of pandemic weirdness, manic exuberance around artificial intelligence and a surprising resurgence of strongman politics are helping to create a thick fog of uncertainty.
To a disturbing degree, the shape of 2025 hinges on the whims of four erratic egocentrics – Donald Trump and Elon Musk in the United States, Vladimir Putin in Russia and Xi Jinping in China. Yet even those strutting power brokers are in the dark on some fundamental issues. Will inflation rebound? Will AI live up to its hype? Will lenders finally balk at the growing mountain of government debt? Your guess is as good as theirs.
In this zero-visibility age, we should be honest about how little we can correctly predict about the year ahead. The evidence, pro and con, was summed up in a note from Man Group portfolio manager Henry Neville. “You can make a strong argument for a very bad year and build a similarly competent case for a very good one,” he wrote. “Push me off the fence and I’ll fall for the former.”
I concur. So what should fence-sitting but wary investors do? Let me offer four suggestions:
Respect Big Mo
In the short term – say, the next six months – it’s hard to argue with momentum, or Big Mo. The U.S. economy is booming ahead at a 3.1-per-cent annualized pace, according to a gauge maintained by the Federal Reserve Bank of Atlanta. Earnings for the S&P 500 are poised to grow an impressive 15 per cent in 2025, Wall Street analysts declare.
This ebullience should help support U.S. stocks over the next few months. It may also spill over to the Canadian market, where the economy isn’t nearly as strong but stocks are considerably cheaper than their U.S. counterparts.
But remember history
The S&P 500 delivered a smashing performance in 2023, notching a total return of 26 per cent. It’s on pace to deliver similarly spectacular results in 2024.
Here’s the thing, though: Such back-to-back bonanzas happen just about never. In fact, only six times in the past 224 years have S&P 500 investors enjoyed consecutive years with 25-per-cent-plus gains, according to Man Group calculations. The average gain the year after these hot streaks? A mere 1 per cent.
If history is any guide, investors may want to keep their expectations for 2025 in check.
Watch those bond yields
Sure, AI enthusiasm has helped whip up investor sentiment, but the quiet, powerful driver behind much of this bull market is Washington’s enormous deficit spending. As students of national accounts will tell you, fiscal deficits tend to reappear as corporate profits.
Will big deficits continue to boost profits and stock prices in 2025? Mr. Trump’s tax-cutting agenda suggests so, but lenders may have something to say about that. Since September, they have started to demand substantially higher payoffs to hold the growing torrent of U.S. debt.
If this trend continues, interest rates won’t fall in 2025 as many had hoped. Bond yields might even go up. Those higher yields would make it more expensive for Washington to run big deficits. They could force legislators to cut back spending and thereby reduce corporate profits. Higher yields could also raise the attractiveness of bonds and make stocks far less appealing by comparison.
No wonder then that Torsten Slok, chief economist at Apollo Global Management, says the growing probability of “interest rates staying higher for longer is the number one theme in markets as we enter 2025.”
Choose your adventure
From 10,000 feet, the dilemma facing active investors in 2025 is clear cut: Stick with what has worked or gamble on a reversal to the mean?
For the past decade or more, the winning strategy has been to ride market momentum. Investors have grown rich by betting on big U.S. stocks, especially the Magnificent Seven – Apple Inc. AAPL-Q, Alphabet Inc. GOOGL-Q, Amazon.com Inc., Meta Platforms Inc., Microsoft Corp. MSFT-Q, Nvidia Corp. NVDA-Q and Tesla Inc. TSLA-Q
It’s not clear how much longer that can continue. At today’s sky-high valuations, the Magnificent Seven, and U.S. stocks in general, are painfully expensive.
It may, therefore, be time for wary investors to consider diversifying into areas that have lagged behind. Many value stocks look cheap. So do European stocks.
The problem is that you could have made the same observation every year since 2015 and been wrong. So will this be the year that markets finally turn? Maybe, but it’s far from a sure thing.
As always, an internationally diversified portfolio of low-cost index funds, with 60 per cent stocks and 40 per cent bonds, remains a smart choice. No, a 60-40 portfolio won’t shoot the lights out. But at least it means you don’t have to forecast. And there is a lot to be said for that.