Believe it or not the US economy and stock markets have performed well over the past 20 years regardless of which political party controls the Executive Branch (President) of Government. The most impactful economic policies are derived from Congress, especially tax and spending policies. While the airwaves are filled with various tax proposals and spending initiatives, Congress will be the final policy makers which the President will either sign or veto. As you know me well, I continue to embrace the guideline “Follow the Money”. The House of Representatives and Senate members are sensitive to both their voting constituents as well as their donors who can impact a member’s re-election. Therefore, I do not believe that Social Security taxes will be eliminated, unrealized capital gains will be taxed, and the grab bag of giveaways will be legislated by Congress.
Federal government spending is unsustainable on its trajectory with federal government spending the equivalent of 24% of Gross Domestic Product “GDP” up from 20% just five years ago. Federal tax revenue increased 3.4% annually, while spending increased 5.0% annually during the past five years. While wasteful spending is always discussed, the primary culprit is social entitlement spending (Social Security, Medicare, and Medicaid). These programs are growing at rates greater than GDP which is mathematically unsustainable. If a credible plan is put in place to resolve the problem over the next 7-10 years markets will applaud these policy changes with bond and equity markets rising. Spending constraints and tax increases will likely need to be included in such a policy. The alternative will be that investors will not buy US Treasury bonds unless yields rise to a level to compensate for the additional credit risk. This would likely cause equity and bond markets to decline, reflecting a weakening economy.
In the near term we expect the stock market to perform well during the next 12-18 months with interest rates heading lower and corporate earnings expected to rise 10-12% in each of the next two years. The FED commenced a rate reducing cycle in September 2024 after the U.S. inflation rate retreated and approached its 2.0% target. The Fed Funds rate is the interest rate which the FED sets and is the interest rate upon which many loans are based. The Fed Funds rate is currently 4.9% and the futures market is expecting it to be 3.6% by the end of 2025. The FED is in the process of shifting monetary policy from being economically restrictive to being neutral. The following chart illustrates the Fed Funds rate trajectory.
…And when the FED reduces interest rates stock markets tend to rise during the ensuing 12 months. Charles Schwab & Co. Inc. looked back at all the 14 times the FED reduced interest rates since 1929, and 12 of the 14 times the stock market was up 12 months after the first cut.
Corporate earnings are expected to rise 24% over the next two years. These estimates are for the S&P 500 Index, which is heavily weighted toward the top seven rapidly growing companies in the index. Excluding these seven companies, earnings are expected to rise by 18-20%. While interest rate policy has a direct effect on the stock market, corporate earnings and dividends are essential for stock prices to rise.
2025 Outlook
Positive Tailwinds
- Inflation is heading to the FED’s 2.0% target
- The FED continues to reduce interest rates.
- Earnings of companies in the S&P 500 Index are expected to grow 10-12% in 2024 and 2025
Negative Headwinds
- Federal deficit spending continues to put upward pressure on prices by adding to “demand” in the economy, and thus inflation.
- Federal borrowing to fund the deficit “crowds out” the private sector from obtaining necessary capital for private economic growth.
- Geo-political risks – low probability and high consequence of China militarily controlling Taiwan, and thus global semiconductor supply.
Rich Lawrence, CFA November 4, 2024
DISCLOSURE:
Opinions about the future are not predictions, guarantees or forecasts. Investing in stock and bond markets have risks that could lead to investors losing money.