| Palacios’ Perspectives Week ending January 3rd, 2025 2025 Investment Outlook |
Market / Macro Economic Summary
As I begin to outline my thoughts for expectations for 2025, let me start with the fact that enthusiasm “should” be tempered as the S&P 500 (500 largest U.S. based stocks) have gained more than 20% in back to back years. This has happened only four times in the last 100 years! Analogs will not be helpful in forecasting third-year expectations as in two of those four instances the markets were down the following year and in the other two the markets were higher. Back to economics 101, base expectations have most economists looking for U.S. Gross Domestic Product (main measure of economic growth) to be up 2.5% for 2025. Coincidentally, inflation expectations are flat as economists expect 2.7% inflation but more importantly 2.1% core inflations (when you exclude housing). I’ve discussed in the past how housing inflation readings lag the true market by 6 months or more, so the “core” CPI (Consumer Price Inflation) is the better metric. This 2.1% is close enough to the Federal Reserve’s 2% target, therefore, Jerome Powell and team should hold interest rates steady or maybe slightly decrease 1-2 times in 2025. Consumer spending should remain robust and, as our economy is 70% driven by the consumer’s spending, this bodes well for this year’s returns too.
There is this one little thing I’ve purposefully avoided until now. There was this election that occurred in the U.S. that brought a Republican sweep in Washington. President-Elect Trump will bring business deregulation, lower taxes and the “threat” of new tariffs. While the first two are positive to capital formation and economic activity, tariffs are the main concern I have in 2025. At the moment, I believe he will be more “talk than action” on this, but if he does implement the type of tariffs he’s talking about, the impact will be borne by the American consumer in the way of higher prices for goods and at the pump. This will obviously hurt my market outlook.
Another point I’d like to make on the macro economic perspective, America remains the “safest” house in the worldwide neighborhood. Eurozone countries remain teetering between growth and contraction. Unemployment remains 6.3% in Europe (4.2% in the U.S.) and manufacturing remains challenged as well, most notably with Germany’s PMI ending the year at 42.5 despite being at 43 in the prior two months. For context, a PMI reading of 5o or more demonstrates signs of a growing manufacturing segment while under 50 reflect low orders and economic contraction. China doesn’t endear one for optimism either. They continue to pump a myriad of stimulants into their economy to stimulate growth due to its seriously impaired real estate market. Expectations for Chinese GDP growth are below the 5% its government is looking for. India and Mexico currently sit as emerging markets with high growth rates, but investments in these markets remain too speculative from a risk/reward standpoint.
All of this is to bring me to a conclusion that domestic-centric investments remain the best way to secure positive returns. I think equities will still outperform fixed income but other options such as alternatives and private credit will help diversification and thereby bring alpha. I want my clients to set expectations for 8%-10% returns for 2025. I want to caution that while I read a lot and follow many great minds of economic activity, I agree with Tom Lee, founder of FS Insight, that the year’s returns could be front-loaded and the back half of the year might be a little more tricky. In other terms, I would not be surprised to see a 15% return mid-year but yet have a decline of 5% in the second half and we end the year at a plus 10%. Why do I think this? One reason, for example, is that “if” Elon Musk and Vivek Ramaswamy, as part of Trump’s DOGE (Department of Government Efficiency), prove to be successful in cost cutting, this could decrease defense spending, governmental hiring and other things that could impact equity returns. This of course is something that would take time to materialize hence why I say that this could impact second half of the year returns.
In closing, I think the base case for U.S. economy and stock market growth is positive for 2025. I think earnings expectations of 9% growth can be easily beat and the Price to Earnings multiple on the market will be justified.
Company Specific / Micro Economic Summary
On the micro economic side, I’d like to focus on sectors or themes that I believe will work in the coming year.
Agentic Artificial Intelligence
Get used to this new terminology. Companies such as Salesforce (Agentforce), Microsoft (CoPilot), Google’s Gemini or DeepMind, Anthropic’s Claude, Amazon’s Alexa, Apple’s Siri… are all examples of how AI (artificial intelligence) is being implemented within organizations to bring the ever-important ROI (Return on Investment). While lots of critics are debating the billions of dollars being spent on building out LLMs (Large Language Models), these agentic AI models are the first step towards seeing a direct return on investment to this spending. I do believe investments will still continue into hardware and chip makers like Nvidia, AMD, TSM…..but 2025 should start the year of monetizing those hardware investments towards revenue-generating agents. I am still bullish in the next twelve months in this area.
Cyber Security
This theme carries over from last year. As we move further in the technology landscape, now you’re hearing of AI being used for malicious attacks. We will remain in an environment where board of directors will continue to prioritize investments in cyber security because regulations such as Sarbanes-Oxley (2002) force their hands to do so. We should continue to see good results from Crowdstrike, Palo Alto, Sentinel One, etc.
Small/Mid Caps
The year of catching-up! As previously mentioned the markets have had back to back 20%+ returns in the last couple of years. Last year the Russell 200 Index was up 12.48% while the S&P 500 was up over 24% and the tech-heavy Nasdaq was higher by 31%. I believe the economic environment will uniquely help Small and Mid Caps and allow them to catch up to their large cap brethren.
Alternatives
Other types of investments now available to retail investors, from covered call funds to private credit to structured notes are quickly becoming ways to generate “alpha” or excess returns. I think we continue to see what I call a “democratization” of investment options. What I mean here is that Wall Street is opening the door for more investment options to RIAs (Registered Investment Advisors) like myself and this will help in portfolio construction. I will continue to attend conferences and seminars to keep up-to-date on products/tools and investments that will help my clients do better.
Parting Thoughts
As we journey into 2025, my promise remains simple. Keep working hard to stay on top of economic and company-specific factors that will affect portfolio performance.
I will continue to look for new investment ideas and create income/growth where possible.
Once again, THANK YOU for your continued trust!
I welcome an opportunity to discuss the above detail and wish us much success in 2025!
Regards,
Erick J. Palacios, MBA
Wealth/Fiduciary Advisor
Parting Thoughts
As we journey into 2025, my promise remains simple. Keep working hard to stay on top of economic and company-specific factors that will affect portfolio performance.
I will continue to look for new investment ideas and create income/growth where possible.
Once again, THANK YOU for your continued trust!
I welcome an opportunity to discuss the above detail and wish us much success in 2025!
Regards,
Erick J. Palacios, MBA
Wealth/Fiduciary Advisor