We had two strong years in a row for capital markets, and there’s no good reason for a bull market to end simply because the two years prior were good. Statistically, there’s no relationship that prior returns tell us anything about what will happen the following year. That’s also true for valuations, the stock market, and individual stocks.
That said, some things might happen this year to create economic difficulties. We know the world’s going OK, but when the world goes OK, excesses can build up, and outside of the equity markets, excesses are building up. Excesses are building in private credit, public debt, alternative investments, and alternative energy. Could some of these excesses create a bubble in 2025 or 2026? At this point, it’s too early to speculate because excesses and euphoria can build far more significant and for far longer than anyone deems rational.
So, what is running normally? Inflation has returned to normal levels in terms of year-over-year change, which is around 2.7%, and we need to remember that this new rate is what’s relevant to the market, not the +20% increase since February of 2020 that was difficult for everyone globally. The market only cares about what happens moving forward, not the past, and moving forward inflation looks benign. 2.7% is a nice positive for 2025.
Additionally, the media often leaves out that employee compensation and disposable income are now outpacing inflation. And productivity has been up 2.6% annually over the past 6 quarters. Compare that with 1.6% from 2015 to 2019. That is a nice positive because productivity helps lead to a better economy.
Moving to US President-elect Donald Trump. Whether you like the incoming president or not, incoming presidents are usually more popular and have more political capital coming into office than they do at the end of their term. Accordingly, in the first 100 days of the new administration, we will watch to see if any meaningful legislation is enacted. If so, will the new legislation make markets more confident or more uncomfortable? This uncertainty switch can be powerful, which is often why a US president’s inaugural years can nicely boost capital markets or bring a new bear market.
Remember that markets can only do one of four things in a year. They can be up-a-lot (+20% or more), up-a-little (0 to +19%), down-a-little (-1% to -19%), or down-a-lot (-20% or more). A down-a-lot scenario does not look probable in 2025. More probable is that markets dip slightly negative in 2025, grind out low-single-digit gains, or boom up-a-lot +20%. And December 18th’s steep tumble could anecdotally be a bullish sign. Since World War II, 114 S&P 500 days dropped 2.5% or more shortly after a bull market high (57 in 2024). Over the following 12 months, stocks were positive 87% of the time, averaging +20% returns.
Three years of +20% returns in the stock market might feel uncommon, but it isn’t absurd because the average return in a bull market is 23% yearly. That is precisely why first-world stock markets average 10% over the long term—including all bear markets. As a side note, we now have more years in the S&P 500 total return since 1950, when stocks gained 20% or more (22 times) than had a negative year (21 times).
In closing, early in 2025, one of the trends above will emerge dominant. We will be watching the Trump administration closely over the next 100 days to determine how the rest of 2025 might unfold, but for now, lean into another positive year—positive single digit to +20% returns cover 2/3rds of the probabilities.
