The New Year is officially underway. Following an exceptional 2024 for stocks that ended with an oof and included a surprise election sweep along with lingering inflation concerns that just won’t quit as evidenced by the uneven year for bonds, what are the key indicators to watch for what to expect as we move freshly into 2025. The following are five indicators to watch for 2025.
- Corporate Earnings. Profits are the mother’s milk of rising stock prices. And this is borne out by more than 150 years of stock market history. If corporate earnings growth is rising, stock prices are also very likely to rise all else equal. This has historically been true regardless of valuations, which at 26 times earnings on the S&P 500 today is about as expensive as stocks have ever been. And if corporate earnings growth is falling, stock prices are at high risk of falling, often precipitously when valuations are expensive. For these reasons, keeping a laser sharp eye on the state of corporate earnings will be critical in 2025.
Here is where we stand heading into the New Year. Corporate profits have been rising on an operating earnings basis at a steady mid-single digit pace since 2023 Q3. And looking ahead through the end of 2025, they are currently projected to accelerate toward a mid-teens growth rate.
Needless to say, profit expectations are robust. And if corporations can hit this high profit bar as they have for the last couple of years now, then stock prices should respond accordingly to the upside. However, if corporate profits fall short of these lofty targets as we progress through the year, this is likely to have a dampening effect on the S&P 500 furthering its strong advance dating back to Halloween 2023. And if profit growth were to actually fall toward turning negative along the way, which is a long way off from current projections but is not unheard of in past episodes, then hang on for potentially bruising downside. We’ll learn a whole lot more in this regard when fourth quarter earnings season gets started in earnest the week after next in mid-January.
- The Yield Curve. The inverted yield curve over the last few years has been well documented. This upside down world condition where investors are getting paid a higher yield for lending money to the U.S. government for a shorter period of time (3 months, 2 years) than a longer period of time (10 years, 30 years) historically occurs because investors are willing to receive less in yield now for owning longer dated bonds so they can lock in these rates for a longer period of time. Why would they want to do this? Because they likely think the economy is going to fall into recession, and the Fed will need to cut short-term interest rates to revitalize the economy.
How useful is this indicator? It has predicted 13 out of the last 13 recessions. What haven’t we had yet since the yield curve first inverted in 2022? A recession. What tends to fall during economic recessions? Corporate earnings growth. Just sayin’
Maybe it’s different this time. After all the yield curve has been steeping sharply since last summer. Perhaps we’ll emerge from this latest inversion finally unscathed. Maybe, as we have seen many financial market “firsts” in recent years and the yield curve indicator may be no exception. Nonetheless, it is important to note that many of the past recessions that the inverted yield curve has predicted finally took place once the yield curve was steepening toward normality. Why? Because the Fed was in the process of cutting short-term rates in anticipation of the recession that may lie ahead. What has the Fed been doing in recent months? Cutting interest rates. Once again, just sayin’. Stay tuned.
- Inflation Expectations. It has been a primary downside risk for capital markets for the last two years now. The sudden and sharp rise in inflation emerging from the COVID crisis sparked a bear market in both stocks and bonds in 2022. And while inflationary readings have been steadily on the mend in the more than two years since, pricing pressures continue to linger under the surface that could rekindle into another larger inflation problem if policy makers aren’t careful. If inflation rises anew, both stocks and bonds are not likely to be pleased. Thus, watching pricing readings closely will be important in guarding against a renewed inflation outbreak.
Now one could wait for the once-a-month readings that come from the likes of the U.S. Bureau of Labor Statistics (Consumer Price Index (CPI)) or the U.S. Bureau of Economic Analysis (Personal Consumption Expenditures (PCE) Price Index, which is the Fed’s preferred inflation measure), but having a more real time daily reading is more useful when navigating financial markets.
This is where the 5-Year Breakeven Inflation Rate from the Federal Reserve Bank of St. Louis comes in handy. This is a daily reading that provides a measure of expected average inflation over the next five years based on the spread between the yield on the 5-Year U.S. Treasury note and the 5-Year TIPS note.
Where do we stand today with inflation expectations? Overall, this reading remains firmly in control at 2.38%, which is not far above the Fed’s target inflation rate of 2%. Good stuff. But it does remain elevated well above the 1% to 2% range that marked much of the post Great Financial Crisis period where the Fed had the monetary policy luxury to pin interest rates at 0% and engage in quantitative easing like a drunken sailor. In other words, don’t expect the Fed to go to zero and start buying assets the next time the stock market sneezes. Moreover, the key line to watch on the 5-Year Breakeven Inflation Rate is 2.5%. If we break meaningfully above this level over the course of the next year, it may suggest that the inflation beast is breaking back out of its cage, and neither stocks nor bonds are likely to like that none too much.
- CCC Spreads. It’s not good enough to simply hear that markets are flush with liquidity. As an investor, you want to see it. And the additional premium that investors require to lend money to the borrowers that are most likely at risk of default with credit ratings of CCC or lower is a good way to gauge the abundance of liquidity in the marketplace. Why is this the case? Because if money is hard to come by, you are going to take extra measures from a risk control perspective to protect it. Conversely, if money is easy to come by, you are increasingly willing to take a flyer on higher risk investments to capture a little extra yield.
So where do we stand today with CCC and lower spreads, or the additional premium that investors are requiring in yield over comparably dated U.S. Treasuries to take on the risk of lending money to these most at risk borrowers? These spreads remain near historically tight levels, which means that investor risk appetite and the liquidity that feeds it remains highly abundant.
This is a resoundingly positive sign for risk assets as we enter the New Year. It also remains an important indicator to watch closely as we progress through 2025. This is due to the fact that it is among the leading-est leading indicators that a turn in broader market fortunes may be coming. As a prime example, CCC spreads bottomed and started rising in May 2007, a full five months before the S&P 500 peak in October 2007. And we all know what followed in 2008 and 2009.
- Cryptocurrencies. Yeah, I know. There’s two schools here. Either you love it and think its going to change the world – relentlessly long – or you think it’s a nonsense quasi ponzi scheme where “investors” try to sell an asset that’s backed by nothing to the next investor that’s willing to pay even more for this currency that really isn’t a currency (no store of value, no unit of account, no medium of exchange except for maybe some goods that you don’t want to bring home to grandma) – relentlessly avoid. Regardless of what you may think about cryptocurrencies, the fact remains that it is another highly useful barometer of market liquidity, particularly for the biggest and baddest tech stocks that have ruled the stock market school for the last several years.
Although the magnitude of the price movements are decidedly different, the correlation of price performance between cryptocurrencies and the Mag 7 heavy NASDAQ 100 Index is very high. When cryptocurrencies skyrocket, the NASDAQ 100 typically rises. When cryptocurrencies are crashing, the NASDAQ 100 typically falls. And when the two are traveling divergent paths for a period of time, they typically eventually reconverge. And more often than not, cryptocurrencies will start moving in a direction first ahead of the NASDAQ 100. As a result, if cryptocurrencies continue to soar, expect that tech leaders will continue to reign over the stock market. Conversely, if cryptocurrencies start taking the elevator to the downside, beware what may befall these long established market tech leaders along the way.
5 for 2025. These are just a few of the key indicators worth watching as we make our way through 2025. The capital market environment remains healthy and the outlook is strong. But risks remain that could derail these positive expectations. Stick to your long-term investment plan, but also keep a close watch on the risks that may require adjustments to the course along the way.
I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Investment advice offered through Great Valley Advisor Group (GVA), a Registered Investment Advisor. I am solely an investment advisor representative of Great Valley Advisor Group, and not affiliated with LPL Financial. Any opinions or views expressed by me are not those of LPL Financial. This is not intended to be used as tax or legal advice. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. Please consult a tax or legal professional for specific information and advice.
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