Despite a down day Friday, on light volume, 2024 was a very solid year for equities. But it hasn’t been quite as solid as the performance of the S&P 500 might suggest. The leading average is up over 25% with two trading days remaining, the second 20%+ year in a row. But the equal weighted average is up less than 12% and 30% of the components making up the average are down year-to-date. Thus, what looks like a very robust year has actually been a very bifurcated one. Technology and financials were the big winners. Taken together, everything else has been a mixed bag.
But that is backwards looking. What might 2025 bring? I will explore that thought this morning, but before I do I will enter one caveat. In most times, what emanates from the White House is less important than what emanates from the Fed. Trying to predict what the Fed might do has been rather fruitless over the past few years. That’s more a fact than a condemnation of Fed policy. While there are many Fed critics out there, reality says U.S. GDP has been growing close to 3% in real terms with an inflation rate now down close to 2.5%. While the inflation rate remains a big high, it will remain the Fed’s primary focus until either the pace slows toward its 2% target, or the labor market weakens to the point where unemployment rises to unacceptable levels.
With all that said, given all the proclamations coming from Donald Trump as to what he intends to do, some of his actions will be meaningful economically. Therefore, let’s look at them.
Immigration, deportation and the size of the workforce – During the campaign, Trump promised to deport as many as 20 million illegal immigrants using the National Guard if necessary. But campaign bluster has already moderated significantly. This past week, there was much discussion and debate within Republican circles surrounding various forms of visas that might be needed to insure an adequate supply of trained and seasonal workers. One side said certain skills are needed; the other says “send them all home”. Trump himself hasn’t taken a firm stand but allows that some visas may be necessary. For the economy there are two keys. First, is having the labor supply needed to keep the country growing at or near its current pace. Obviously, seasonal workers are needed, for instance, to pick crops. The other factor to consider is whether the paces of both deportation and limits on new immigrants will tighten the labor supply to a point where wage inflation starts to spike.
Mass deportation isn’t going to happen overnight. It’s a process that will play out for months, if not years. Because it will be more a slow walk than an immediate surge, observers will be able to judge and moderate the impact. If there are significant signs of labor supply squeeze, it could lead to a moderation of the deportation process.
Foreign Policy – Normally, investors don’t focus heavily on foreign policy. When the Russia-Ukraine war broke out, there was some panic over the price of key commodities, especially wheat. But three years in, the economic impact of the war has been minimal. Ditto the conflicts between Israel and its neighbors. None of the direct participants play a meaningful role in world economic supply and demand. Likewise, North Korea bluster has little impact on markets. With that said, there will be a focus in 2025 on both Iran and China.
Iran had multiple setbacks in 2024 both directly and through its supported terrorist organization failures. Iran is important economically as a significant oil producer. With that said, it is far smaller than the U.S., Russia and Saudi Arabia. There is plenty of additional available supply to make up for any shortfall in Iranian oil should Trump decide to increase sanctions there.
That leaves China. Trump promises big tariffs on imports from China. Biden has already limited exports of high-tech products to China. China wants to assimilate Taiwan at some point as it has done with Hong Kong. These all have meaningful impact on our economy.
China has its own economic problems. Growth is slowing and debt is choking its financial system. Population has begun to decline. Consumers are hesitant spenders as a result. China’s traditional reaction of accelerating infrastructure spending and exports won’t be as effective this time around, especially if Trump increases tariffs. At the same time, it is illogical to expect that 10 years down the road, the world is going to move forward technologically on two totally separate glidepaths that never intersect. That issue isn’t going to be resolved in 2025. But just as sanctioned nations seem to find ways to function with some degree of normality, China is going to advance at a pace, technologically, that will rival the rest of the world whether it is allowed to buy Nvidia chips directly or not.
Taxes – Ideally, the Trump White House will want to extend and expand the 2017 tax cuts as quickly as possible. The obvious problem is that the wish list is simply too big and cannot be achieved without exploding a deficit that is already uncomfortably high. While the size of the debt doesn’t bother everyone, the cost to service the debt does. Already, debt service exceeds the size of the defense budget and soon will match Social Security outlays. The DOGE team can find lots of savings opportunities, but 77% of Federal spending is Social Security, Medicare and debt service, all considered untouchable by Trump during the campaign. Republicans have the barest of majorities in both the Senate and the House. While there may be uniformity relative to the premise that taxes should be as low as possible, there isn’t clear consensus as to what a final package will look like. Thus, getting a tax bill done is likely to extend past the summer into the fall. And final passage will more than likely require some Democratic help. And there will have to be some concessions to get that help. Perhaps the tax bill will be the single most important piece of legislation this year as it was in 2017.
Interest Rates – In the end, the sum of all the above will impact bond yields all along the curve. Right now, consensus says the Fed will cut short-term rates twice to get them under 4% by year end. But don’t bet on that prediction. Last year at this time, markets were worried about recession and were looking for 6-7 rate cuts in 2024. In essence, the economy in 2024 grew faster than expected and, as a result, inflation came down slower than expected. A big surprise was better than expected productivity gains. At the long end of the curve, it will be all about inflation. Despite all the noise surrounding DOGE, Trump likes to spend and he isn’t afraid of taking on debt. But he doesn’t set long-term rates. If they surge to or past 5%, markets will force his hand. Wall Street will be the ultimate arbiter of his economic policies.
As we enter 2025, the expectation is that growth will continue. It is hoped that productivity improvement will stay above historic norms. AI may help but it’s too early for the impact to be significant. Thus, the pace of improvement is an important unknown. Trump’s proposed policies are both inflationary (e.g., tariffs), and accelerants to growth offset by any disruptions that might be caused by changes in immigration policy. Foreign affairs are a wild card as always. But it is unlikely that China will want to go too far provoking Trump early in 2025 in a manner that will have significant economic consequences. Tax policy is clearly important. Something will have to pass in 2025 but Congress isn’t likely to get anything done with any haste. 2024 showed us how ineffective the House Republican majority can be and that majority is even smaller in 2025. Bottom line is that little of economic significance is likely to pass in 2025 without bipartisan support. The early bluster won’t sound that way but reality will set in as the expiration date for the 2017 tax cuts approaches.
Interest rates will be the ultimate arbiter of the success of the Trump agenda. It’s much too early to make any prediction because we don’t know what moves ahead and what dies along the way. All Presidents have an early honeymoon. Some of that “good will” probably will be expended getting key appointees across the finish line. A lot can get done early, but not taxes. And we won’t know the inflation impact of what does get done for some months, lending credence to the Fed’s new stance to pause and assess for several months before making big moves.
There haven’t been three 20%+ years of consecutive stock market advances this century. Normally, first years of a Presidential term are a bit rocky and there is little continuity from past to present. That doesn’t mean markets are doomed but it does mean that any real judgment will have to wait until the impact of early policies dictated by Executive Orders can be assessed. Markets are likely to be skittish until clear patterns emerge.
Today, Lebron James is 40. Tiger Woods turns 49.
James M. Meyer, CFA 610-260-2220