My What If Scenarios for 2025: Ranging from Caution to Optimism

Happy New Year to everyone. As we enter 2025, there is a growing sense of uncertainty in the markets about the potential impact of a new direction in Washington. Will it be a continuation of the ‘Roaring 20’s'? Or will we see a retreat in the stock market as President Reagan experienced his 1st year?

Even so, great optimism abounds regarding the technology revolution expected to expand and positively impact multiple sectors of our economy. Hopefully, a broadening of the equity market, from the Magnificent Seven to small caps and international markets, will occur which would be very good for investors. But just as I have often cautioned, we know that hope is not an investment strategy. We also don’t want our decisions to be driven by enthusiasm for what could happen.

In the tradition of A Further Look, I am offering some critical thinking on some important factors that may confirm or contradict current opinion. I again pose them as what-if scenarios for your review.

1. What if the independent Federal Reserve shifts from rate cuts to rate hikes?

The post-election rally has hit a speed bump to start the year. The Federal Reserve pared back its 2025 forecast for interest-rate cuts to a maximum of two, largely because the forces of inflation still exist. A recent jump in ISM Services Prices Paid points to a coming reacceleration in both headline and core inflation.¹

So, what if the Fed should reverse course on interest rates? The biggest loser would continue to be the housing market, which is currently on hold and slower than it has been in decades. This is due largely to the fact that 10yr treasury yields keeps going higher. Typically, when we see the 10-year yield rise, we'd expect mortgage rates to increase. This relationship exists largely because 10-year treasury notes and mortgage-backed securities typically compete for the same investors.

2. What if market forces have a neutralizing effect on the Department of Government Efficiency (DOGE)?

DOGE is focused on right-sizing America’s massive debt and deficit. Trump has tasked Elon Musk (and, previously, Vivek Ramaswamy) with making recommendations to restructure agencies and eliminate waste and excessive spending. Federal spending on interest payments is forecast to hit $870 billion this year — exceeding the $822 billion that the nation will spend on defense in 2024, according to a recent analysis by the Congressional Budget Office.² Such a massive burden on the economy crowds out investment and innovation.

The creation of DOGE represents cutting edge thinking and a departure from the status quo of unchecked spending and neglect. But DOGE is not without its challenges. Keep a close eye on a new controversy regarding H-1B visas. Tech leaders like Musk and Ramaswamy have been deeply critical of illegal immigration, but now defend immigration policies that allow high-skilled foreign workers to stay in the United States legally. This has created a firestorm within factions of the president’s supporters, and could prove to distract from or even derail the efforts of DOGE.

3. On a more optimistic note, what if this administration shifts government’s role from being the enforcement agency of business, to an ally of innovation?

It is pretty certain that there will be reductions in regulations and taxes in the coming year. The early reports, beginning with strong bank earnings on January 15th, are encouraging. Perhaps, this pro-business approach could once again rekindle ‘animal spirits’ in the corporate community and ignite more capital spending, mergers and acquisitions and other investments.

More innovation is good for small cap stocks, which have been in bear mode recently. In many cases, this was because their private equity ownership was hesitant to take them public. With lessening regulation, we may also see more IPO and M&A activity. If this new direction is successful, we could see a stronger economy allowing for a greater focus on peace and prosperity at home and abroad.

4. What if phase two of the AI revolution (data applications) is even bigger than stage one (hardware, servers, computers)?

While we expect AI to remain a dominant theme in the market, it is still too early to accurately determine long-term winners and losers. However, it is clear that AI will have a transformative impact across nearly every industry in the coming years. Even though uncertainties still exist, the next leg of AI opportunities will broaden and include innovative companies well beyond the tech sector over the next decade.

However, given that we are still in the early days of AI, we caution clients to resist the fear of missing out (FOMO) due to the allure of quick gains. As long-term investors, taking the time to fully understand a company's potential (and risks) before we invest is critical in assessing the sustainability of these assets. It is too early to try to pick winners and losers. That’s why we research the right ETFs and Mutual Funds that allow our clients to invest across sectors and gain broad exposure to themes like AI without putting all of our eggs in one (highly uncertain) basket.

Conclusion

With so much uncertainty and issues that remain unsettled, the coming year should provide its share of additional possibilities. Don’t forget about Gold. A reversal of a strong Dollar would favor it as an investment. And what if there are international markets screaming for investment as changes in leadership accelerate free market capitalism? Keep in mind that 41% of S&P 500 companies revenues come from outside of the United States.³

Regardless of what occurs in the year ahead, we don’t think investors should sit on the sidelines and let short-term fears derail progress towards long-term goals. As we navigate 2025, I am looking forward to sharing the journey with you, and look forward to circling back on my ‘what ifs’ in my mid-year update. Let’s stay in the game together.

Thanks for reading.

¹ ISM Services Prices Paid Index https://ycharts.com/indicators/us_ism_non_manufacturing_prices_index

² Congressional Budget Office, The budget and economic outlook, 2024-2034 https://www.cbo.gov/publication/59710

³ Visual Capitalist, How Much Does Corporate America Depend on Foreign Revenue? https://www.visualcapitalist.com/how-much-do-companies-depend-on-foreign-revenue/#google_vignette