Dec 23, 2024 Market Commentary | Looking Ahead: 2025
Earlier this month, Seventy2 Capital celebrated its 8th anniversary. We’re incredibly grateful for the trust and confidence our clients have in our team. This year, we opened new offices, welcomed new team members, and expanded our resources and offerings to give our clients the highest quality service and investment management. Whether you are a new client or have been with us for a while, thank you for the opportunity to earn your trust and business.
As another eventful year in markets winds down, we look forward and share expectations for the coming 12 months for investors. We believe the following themes will drive markets in 2025:
- The Fed’s path of rate cuts – Much of the market destruction in 2022 and growth in 2023 and 2024 were directly linked to the Fed’s decision on interest rates. Will we get the two cuts Jerome Powell alluded to in his recent commentary? Will inflation re-accelerate, leading to a reversal on rate policy? The next few months will shape the direction of the new regime of rate policy, and with it, have a large impact on which areas of the market lead growth in this business cycle.
- Market Breadth – Eventually, we always see a regression to the mean. We did not see it in 2024 as the largest companies continued to dominate the market, but it’s likely that we see more of the market participate in earnings growth and price appreciation in 2025.
- Cash will come in off the sidelines – As deposit rates have stayed up and the equity markets have pushed to frothy valuation levels, capital sitting in cash continues to reach new records. We believe we are close to the peak, and this cash will find its way to various asset classes, supporting liquidity and new investments.
- Geopolitical tensions will take a new form – With the incoming administration, we expect a reduction in military activity globally (and the potential for what we refer to in our industry as a “peace dividend” – capital that’s re-allocated to areas supporting growth other than defense spending). At the same time, we believe we will have a substantial increase in trade tensions between the United States and most major economic powers. Wars in 2024 were fought on the battlefield. Wars in 2025 will be fought with tariffs and trade agreements.
Views on the economy:
Overall, we would give the US economy a grade of B- heading into 2025. It’s important to note that we appear to be in a much better position than every other developed economy globally across the majority of recession risk indicators which we track. As a result, we head into 2025 with an overweight to US vs. International exposure. Unemployment is on a gradual rise, but still at historically low levels, and we don’t see signs of a structural breakdown in the labor market. Inflation has come down substantially from 9%+ in 2022, but still above the Fed’s 2% target, and it has struggled to improve in further reduction over the last 6 months. Policy coming from the Trump administration may be inflationary, but it is still unclear how much of his campaign rhetoric around tariffs was a negotiating tactic vs. what we will actually see in the coming year. Personal and company balance sheets look healthy, while the government’s does not. Conversation around the growing and looming deficit will continue. Although it’s not an area we believe will be a substantial concern or lead to any collapse in 2025, it is an issue that needs to be addressed as an increasing amount of debt service (the amount of interest the government pays on its debt) in a higher rate environment is costly and increasingly stunts economic growth. Consumers are continuing to spend and drive the economy, but we are seeing record levels of credit card debt and increasing risks of default in personal and auto loans.
Views on equities:
US equities have had two exceptional years. Historically speaking, it is unlikely that we see the S&P 500 post a 20%+ return in 2025. Valuations look frothy. Whether looking at metrics of forward P/E (price to earnings), P/B (price to book), or P/CF (price to cash flow), all are trading at 1.4 – 2.2 standard deviations above long-term averages. Statistically speaking, we will likely see some regression to the mean in these figures, which can come in two ways: prices can decrease (investors will pay less for every dollar of earnings, book value, or cash flow) or earnings/book value/cash flow can grow into current valuations. We expect to see low double-digit earnings growth in 2025. More importantly, we believe we will see earnings growth coming from the cyclical areas of the market that have not participated as much in the run up of the last two years (industrials, materials, financials) while companies with substantial increases in capex/AI spend will start to see those costs hit the bottom line and their margins come down from sky-high levels at which they currently operate. We believe markets will broaden out in 2025, which may be the year of mid-caps as we see this rotation take form. Small caps, however, may be too burdened by the higher rate environment to participate.
Views on fixed income:
We enter 2025 with the 10-year treasury hovering around 4.5% after the Fed indicated that they only see two additional rate cuts next year, while the market had been pricing in four to five going into the recent meeting. The proposed policy of the incoming administration may dictate the direction the Fed takes, which will impact our strategy on fixed income portfolios. Based on the information we have today, we believe that the incoming administration favors policy direction for both higher inflation and higher growth. This may mean a new regime of higher-for-longer interest rates. The US will likely lag the rest of the world in cutting rates, supporting a strong dollar. We favor portfolios with a shorter duration, and don’t believe the risk is worth the potential for return in longer-dated fixed income for most investors.
Views on asset allocation:
Given an expected lower regulatory environment, specifically around mergers and acquisitions, and a trend of companies staying private for longer in their growth cycles, we believe that alternative investments should play an increasing role in improving the risk/return relationship in portfolios. The 60/40 portfolio may not be dead in the water, but as we see continuous improvement in technology and access to capital markets, investors may be able to achieve the same expected return with a lower risk profile by incorporating alternative asset classes into their allocation. These may not be appropriate for all investors.
We hope that you have a wonderful holiday season shared with your loved ones. Thank you for being a part of the Seventy2 Capital family.
See you in 2025!
-The Seventy2 Capital Team
Commentary and Research provided by:
Michael Levitsky, CFA®, CAIA® – Managing Director, Investment Strategy