The S&P 500 had a fantastic 2024. The index returned almost 30% as it was driven higher on the hopes of increased productivity and margins through the use of Artificial Intelligence. Semiconductor stocks that design the specialized chips used in AI saw their stocks explode. Big tech companies such as Google, Microsoft and Meta bought billions of dollars of chips to power Data Centers used to train their large language AI models. Plenty of other AI adjacent names such as utility stocks also benefited from the AI hype. Amazingly, the S&P 500 managed this growth in a year where many of the predictions on interest rate cuts were revised lower. Many believed that the economy would show signs of cracking much earlier in 2024, the unemployment rate would shoot higher and the Federal Reserve would be forced to cut rates 6 times. The Fed ultimately cut rates 3 times starting in September for a total of 100 basis points of cuts. 

With 2025 starting, the S&P 500 and more broadly, the American Economy seem to be stronger than ever, however we will look at various factors that all have potential to affect the economy and stock market in 2025. These factors include the 10 year treasury yield staying sticky at 4.5% even after the Fed has cut rates, the historic overvaluation in the market, and the new administration's fiscal policy agenda. At the end, we will discuss why it may make sense to be cautious overall in the short to medium term, yet bullish over the long term. 

Let's start with President Trump’s domestic agenda as it may have the most substantial effect on the markets and economy. The incoming administration has been open with their goals for the economy. These goals include implementing tariffs on imports, stimulating domestic growth through cheap energy and deregulation, reducing immigration, and finally making American manufacturing competitive through devaluing the dollar. 

President Trump’s Agenda: Tariffs

These goals are talked about extensively in a paper written by Stephen Miran, who is expected to lead Trump’s Council of Economic Advisors. The paper describes America as in a Triffin Dilemma. The Triffin Dilemma describes the issues faced by being the world's reserve currency. Currently, there is huge demand for the dollar due its reserve currency status which forces countries to buy dollars to conduct international trade. As global trade increases, America must supply more dollars to the world by selling debt and as a result must run huge deficits at home. Miran argues that tariffs are one form of tax that helps to bring in revenue from other countries to help offset the deficit America is forced to run to facilitate global trade. 

Trump has talked extensively about his plans to use tariffs. Miran describes the use of tariffs as non-inflationary assuming that the export currency also weakens by the same amount. Tariffs generally do have the ability to weaken the currency of the export nation which would result in prices remaining steady. It seems that the biggest threat with tariffs may not be price increases but increased tensions with China. China’s economy has been experiencing slower growth,  and tariffs that cause further weakening of their currency may force China to take more drastic actions or retaliate against the U.S. 

President Trump’s Agenda: Energy and Deregulation

Another well talked about goal of President Trump’s is increasing energy availability and reducing regulation. Trump has been clear that he supports further production of fossil fuels in places such as the Gulf of Mexico and Alaska. Trump also seems to have indirect support for nuclear energy as his energy secretary Chris Wright sits on the board of small modular reactor start-up OKLO. Given the importance of plentiful and cheap energy to emerging technologies such as AI, it is hard to imagine that these policies have a negative impact on the stock market and economy. 

President Trump’s Agenda: Immigration

Immigration has been a talking point for Trump even back in 2016 when he promised to build a border wall on the southern border. By reducing immigration, President Trump is reducing the labor pool which is a two sided coin. While reducing the labor supply should increase wages for the remaining labor force, this increased wage may lead to inflation as wage pressure was one of the biggest drivers of the post pandemic inflation. Another issue is that reducing the labor supply also reduces the population at a time where many other developed nations are facing population crises that threaten to stall economic growth in the long run.  

President Trump’s Agenda: Currency

Trump has been open about his desire to reduce the strength of the dollar to make American manufacturing competitive again. Currently the dollar is sitting at levels not seen since 2022 and less recently 2002. The strong dollar makes American exports less competitive abroad in countries with weaker currencies. By definition, weakening your currency is inflationary, which is the major risk in all 3 of President Trump’s policy goals. 

Yield Risk

The risk of future inflation may be getting sniffed out by the treasury market. The 10 year treasury yield has actually risen steadily to 4.5% since September 2024 when the Fed started to cut rates. There are 2 arguments for why this is happening, BofA suggests that the Fed will no longer cut rates and could actually raise rates if Trump’s policies fuel higher inflation. JP Morgan suggests that the 10 year is actually pricing in higher expected future growth. Higher future economic growth is obviously bullish, however it may spur higher inflation which would put more pressure on the already stretched American consumer. 

Yields start to become important as investors look for less risky investments. With the stock market multiples (PE, Shiller PE, Buffett Indicator) all flashing red, investors may start to look elsewhere to earn yield. Bonds at 4.5% to 5% per year are an attractive risk free return. So with all of this in mind, where do I see the market and economy headed in the short to medium and long term. 

Short, Medium, and Long Term Macroeconomic Outlook

In the short to medium term, I believe that there will be volatility. Currently, there seems to be a lot of excitement surrounding the pro-business policies that Trump has proposed, I see risk in two areas. The most likely scenario is that the economy and inflation start to heat up again. Prices have already risen almost 20% since the start of the pandemic with no price decreases (the YOY increase in inflation may be smaller, but it is still positive meaning prices have not stopped increasing from year to year). If inflation starts to increase dramatically again, the American consumer may not be able to spend as much. This is important because America’s economy is driven by the American consumer’s ability to spend. Another stresser on the economy as a result of higher inflation is higher interest rates. Higher interest rates make it harder for companies to borrow and grow. As a result of these added costs, companies may start to cut employees, which again reduces the American consumer’s ability to spend.

Another less likely but possible scenario is economic warfare. Miran’s paper as mentioned earlier, justifies the use of tariffs and currency manipulations as a means of exerting power over other nations. There could be a scenario in which China or other nations look at alternative reserve currencies. This has already started to play out in a few ways namely the BRICS currency effort, the accumulation of gold by foreign banks, and cryptocurrencies. A tangible threat to the dollar’s reserve status would be a huge blow to the value of the dollar and foreign investment in America. 

In the long term, I believe that America’s technological dominance continues and overwhelms all other issues. AI is still in the build out phases. In the medium term there is risk that AI underwhelms and has a less pronounced effect of earnings or margins. This may cause a pullback but it is a buying opportunity long term. Long term, I believe we start to see AI reduce the dependence on human labor which is a boon to the economy. The AI workforce may also reduce the effects of a birth rate crisis that is threatening to destroy other developed economies such as South Korea. Relying on a non-human workforce would result in the ultimate productivity gains which would offset a reduction in the population. 

2025 Market Outlook

As for my prediction on the stock market in 2025, I believe that we start out hot in the first half of the year as there is broad based excitement and bullishness for Trump’s policies. As we get further into the year, inflation and earnings will be the key to the market’s movement. If inflation is consistent around 2.5% and earnings show increased margins from AI investments, then there is no reason we could not see another year of double digit returns. Personally, I see big tech earnings disappointing as the margin and productivity gain in AI is not yet tangible in earnings. This may bring the market lower due to the stocks concentration in the indices. However, I do think there are more traditional value plays that will benefit from Trump’s policies. Overall, I believe inflation is kept under control as President Trump is aware of the importance.

Disclaimer:

Be advised that investments may go up as well as down for any reason, and past performance of a stock is no guarantee of future performance.

Scarton Holdings makes no representation as to the timeliness, accuracy or suitability of any content on this website, and cannot be held liable for any irregularity or inaccuracy.

Stock recommendations and comments on this website are solely those of analysts and experts quoted. They do not represent the opinions of Scarton Holdings on whether to buy, sell or hold shares of any particular stock.

All investors are advised to conduct their own independent research before making an investment decision. Investors should consider the source and suitability of any investment advice for their needs. Your use of this website, and its content, is at your own risk.

Links from this website to third-party websites are in no way an endorsement by Scarton Holdings of their contents or their suitability for any purpose.