A Higher Bar for the Bulls in 2025
Stocks were more volatile last week, highlighted by Friday’s tech-driven market selloff. But importantly, there wasn’t any legitimate reasons for the uptick in volatility and most of last week’s price action, including Friday’s declines, can be attributed to thin liquidity combining with year-end positioning. Money managers window dress their portfolios for show at the end of the year.
Put more directly, the tech sector’s outperformance over the past month was unsustainable and it needed to cool off and that’s part of what happened Friday. But while last week’s volatility can be chalked up to year -end positioning and thin liquidity, the last two weeks in the market have been more volatile and unpredictable than what we’ve become accustomed to in 2024, and I do believe they serve as a clear signal that the bar for more gains in 2025 will be substantially higher than it was in 2024.
Put another way, the market has pulled forward a lot of future positives so just fulfilling those expectations won’t push stocks materially higher. Here’s what I mean:
- The market got rate cuts in 2024 and now expects more of them, so the Fed cutting two times won’t propel markets higher from here (it’ll have to be more cuts than that).
- The market hoped for a “Red Sweep” in the election and got it, but now the new Congress and administration have to actually pass pro-growth policies and keep trade war headwinds and distractions low.
- Finally, investors priced in a soft landing in 2024 and it materialized, but now it needs to stay there and any undo slowing of the economy will spark hard landing fears while any surprise acceleration will reduce the likelihood of any further rate cuts.
Now, higher expectations don’t mean stocks can’t rally in 2025. They absolutely can. But it’s going to take new, additional positive surprises to make that occur, for instance 1) Actual tax cuts and deregulation that’s quicker and more effective than expected, 2) The Fed cutting more than twice because inflation falls quicker than expected, 3) Actual resolution of the ongoing wars in Ukraine and the Middle East and 4) Proof that AI is actually starting to boost profitability and productivity for end user companies (and not just making chip companies earnings explode higher).
If some (or all) of those things happen, then stocks will absolutely move higher in 2025. However, if we spend the first few months 2025 wondering if the Fed will cut once, twice, or at all, while the Republican agenda gets delayed (or derailed) by political infighting, tariff and trade threats are more than expected, and there’s no actual progress on resolving the war in Ukraine (or the conflicts in the Middle East) then we should expect a continued chop sideways punctuated by pullbacks.
Bottom line, the market outlook is positive as we start a new year because of a 1) Ongoing soft landing, 2) Fed rate cut cycle that’s still in place, 3) Reasonable optimism on future pro-growth policies 4) Still-falling inflation and 5) AI optimism. However, we’ll need to see new and better headlines regarding all these events to push stocks higher in 2025 and if they don’t come early, expect more near-term volatility.
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