2024 was one of those years that investors would normally only dream about…
By mid-January, the S&P 500 had already taken out its previous all-time high. From there, it climbed steadily throughout the year.
So too the Nasdaq…
It took out its previous November 2021 all-time high in December 2023 and didn’t stop there. It was a major beneficiary of the artificial intelligence (AI) boom. And eager anticipation of rate cuts drove the rally even higher.
Of course, like any rally, there were several pullbacks along the way, such as in July…
A sharp reversal saw both indexes take major tumbles. And volatility on the CBOE Volatility Index (VIX) spiked to 65.7, its highest level since the start of the COVID pandemic. (Its average is around 19.)
From high to low, the Nasdaq and S&P 500 lost around 16% and 10%, respectively, in less than a month.
But buyers’ confidence quickly returned. Both indexes recovered and went on to make fresh new highs. Meanwhile, the VIX dropped to around just 13 as we rolled through December.
So what should we expect going forward?
Well, last year’s market euphoria may roll into this year… But I think it’s going to be short-lived.
Because come January 20, President-elect Trump’s inauguration will take place.
And everything could change quite dramatically in the weeks that follow…
Trade War
We all know about Trump’s proposed tariffs. But the market underestimates how big their impact might be.
More expensive imports will send prices (and inflation) higher.
So I expect the U.S. economy to start strong in 2025. But it will weaken as the impacts of those tariffs start to bite.
And this is going to cause a lot of uncertainty.
The market is priced for perfection right now. So this uncertainty will challenge stocks’ lofty valuations.
Remember… it won’t be offshore manufacturers in China and elsewhere absorbing the cost of the tariffs. The American consumer will pay them.
That’s you and me.
Late last year, one Bloomberg estimate projected the proposed tariffs would add 0.5% to consumer inflation. (Plus, Trump’s plans to cut income taxes and beyond could add another 0.4%.)
Put simply, tariffs will drive up inflation and keep interest rates higher for longer than the markets anticipate. And it could even force the Fed to increase rates. (More on that below…)
The other side effect of tariffs, is, of course, a trade war.
We’ve already seen early shots fired. As just one example, China targeted Nvidia (NVDA) last month with an antitrust investigation.
And we can expect these tit-for-tat retaliatory moves to increase the longer any trade war goes on.
The broad consensus is that the U.S. would win any trade war, given that the U.S. is China’s largest export market (representing 15% of all Chinese exports).
But trade wars can become extremely messy with no clear winner in the end.
Plus, I think the U.S. has more to lose than many people imagine. There is a huge disparity between our countries’ economies…
The U.S. economy has been powering along. But China’s growth has slowed dramatically. Its economy continues to struggle.
We’ve all seen numerous stories about China’s real estate problems. Yet Chinese equities late last year were still trading around half the level they were at their February 2021 peak.
My point is this: Why would you upend the apple cart with a trade war when things are going so well for the U.S. in comparison to China?
The U.S. has a lot more to lose out of a trade war than China does.
But it’s not just the tariffs and potential trade war that concern me…
We’re going to see a big round of cost-cutting and reduction in government spending as Trump’s policies flow through the economy.
That will throw a big wrench into the markets. When you take a chunk of demand out of the economy, it has to have flow-on effects.
So what else am I expecting to see?
A Jump in Volatility
We’re likely going to see a big increase in volatility in 2025.
As I mentioned above, VIX volatility stayed around 13 in December. So essentially, it has nowhere to go but up…
And a major unknown that could spur volatility will be the geopolitical landscape this year.
In December, after five decades in power, the Syrian ruling family collapsed practically overnight. How that plays out in the wider Middle East conflict is yet to be seen.
Add in uncertainty on how Trump is going to deal with Russia (and Ukraine) and any other unforeseen conflicts, and we’re sure to have some surprises ahead.
Altogether, I’m expecting geopolitical events to have a bigger impact on markets than last year.
But now I want to return to higher inflation… and how that will impact interest rates.
Sticking Around
Inflation might not get as high as earlier in this cycle. Yet it has a habit of staying around much longer than markets expect.
Look back at the oil shock in the 1970s that caused inflation to spike. On that occasion, inflation ultimately didn’t peak until around 1980.
Now, I’m not expecting something near that magnitude this time. But I’m expecting inflation to remain sticky throughout 2025.
I suspect the markets will have a “neutral” bias on interest rates early this year as a result. But as the year progresses, I expect that to change.
In fact, by the middle of the year, the market bias could change to “tightening” expectations… with interest rate increases likely.
In fact, we could not only see higher interest rates by the end of 2025… 10-year bonds could trade above 5.0%.
That will add another layer of weight to the market.
I’m expecting stocks to remain stable until the end of January. But after that, all bets are off…
My prediction for the year is that both the S&P 500 and Nasdaq will finish 2025 down.
There’s too much uncertainty and weight hanging over a market already priced for perfection.
AI-themed stocks and Big Tech were the engine room of much of the rally in 2024. Yet they have become way over-owned. That makes them vulnerable to a correction.
So between the two indexes, I expect the Nasdaq to underperform the S&P 500.
The other thing to consider is this…
The total combined value of Germany’s top 40 stocks (DAX 40) is around $2.02 trillion. The 40 biggest French stocks (CAC 40) combined are worth around $2.47 trillion.
By comparison, Apple (AAPL) alone has a valuation of around $3.75 trillion. It easily dwarfs either market.
The same is true of both Nvidia (NVDA) and Microsoft (MSFT) with valuations over $3 trillion.
When just one U.S. company is worth almost as much as 80 of the largest European stocks, something is out of balance.
That could provide the setup for a major correction if this dynamic reverses.
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Final Thoughts
Tied to all the predictions above, I think we could also see lower commodity prices.
With a trade war between the globe’s two biggest economies, economic activity will fall.
As such, I remain bearish on oil.
I also remain wary about gold… Gold has a habit of pulling investors in… right before it rolls over. That causes plenty of disappointment.
But gold could see a resurgence in the second half of this year if inflation gets out of control.
We’ll also want to keep a close eye on Bitcoin. It surged off the back of Trump’s win, given his support for cryptos and his desire to make the U.S. the world leader in digital finance.
However, after such a sudden and sharp run-up, I’m wary of a major pullback. So stay cautious if you want to play in that arena.
One final thing…
I realize that many of my predictions sound gloomy. But these are simply the outcomes I expect from the conditions I see.
There is good news, though!
Trading is often very profitable in moments of turmoil and uncertainty.
There are going to be a ton of tradable moves in 2025 if even a fraction of my predictions proves true.
So if you’re ready to take advantage of the opportunities that arise, there’s no reason why 2025 couldn’t be one of your best years yet for achieving your financial goals.
I aim to help you get there. I’ll continue to offer my best advice for how to navigate the markets in the weeks and months ahead.
So thank you for being a reader. I wish you all the best for the coming year.
Regards,
Larry Benedict
Editor, Trading With Larry Benedict