2025 Outlook: Inflation Cools as AI Lifts Earnings

Newsletter — January 2025

Dear Clients and Friends,

As we approach the end of 2024, we wanted to take a moment to reflect on the year and discuss a few thoughts heading into 2025.



The past year has been a year of significant newsworthy moments, historic elections, and market movements highlighting both challenges and opportunities.  The US showed economic resilience, buoyed by a stable labor market, growth in retail sales and consumer spending, as well as a recovery of sorts in manufacturing.  Inflation has gradually cooled from its peak, but incremental gains are proving to be a bit challenging due to sticky rents and wages.  Real wage growth remains positive, though, helping to fuel consumption.  Goods inflation remains subdued, whereas service-sector inflation continues to run higher than pre-pandemic levels.

The mostly favorable economic backdrop has put the Federal Reserve in an interesting spot.  The desire to lower short term interest rates is confounded by recent economic strength potentially driving a resurgence of inflation, not to mention the short-term potential impact of tariff increases under Trump 2.0.   

Investors list inflation, geopolitical tensions, and trade protectionism as the three main economic risks heading into 2025; meanwhile, a trade war, Fed rate hikes due to unexpected inflation, and a persistently strong dollar are viewed as potentially the most bearish developments next year if they materialize (see thoughts below on interest rates).  Longer-term interest rates have gone back up as of late, and the yield curve has finally un-inverted following a prolonged stretch.  Although mortgage rates have moved up in tandem with 10-year treasuries, we saw an increase in existing homes sales last month for the first time since 2021.

US equities have generally performed well, driven by strong corporate earnings and optimism around AI.  This, in turn, has added to the wealth effect contributing to consumer spending. Stock markets have also responded positively this year to increased liquidity and corporate profits, although earnings estimates for 2025 have been coming down over the past few months.  That has resulted in a richly valued market, but not for all stocks. While I’d expect a bit more volatility in the overall index heading into 2025, I see value and small cap stocks as having particular value as the dust settles. 

As I’ve noted many times, Mr. Market does not like uncertainty, and we should continue to stay “eyes wide open” regarding potential shifts in fiscal policy and the economic outlook. On balance, there appears to be a good case to be made for markets to reasonably perform in 2025, although I would not bet on a repeat of the past couple years.  I think the easy gains have been made, meaning that a consistent, diligent approach to diversification and asset selection will likely be key going forward.   

While it’s a bit odd to think the Federal Reserve would continue to cut rates while investment markets remain relatively exuberant, I do think the Fed will cut interest rates modestly next year.  With some economic tailwinds heading into 2025, I think monetary policy expectations will need to be tempered, however, and eventually a new consensus will develop.  I’m optimistic by nature, and I respect the value and comfort of having a long-term investment horizon.  New year prognostications are often wrong, and I tend to place greater value in economic and valuation trends versus time-specific year-end targets.  At this point, there is every reason to believe that, through long-term planning and strategy, we will be able to navigate the near-term uncertainties which lie ahead.     

I hope you and yours have a wonderful and prosperous new year. We appreciate the trust you have placed in us and look forward to continuing to serve you in the coming year and beyond. 

Sincerely,

Eric C. Boyce, CFA

President & CEO