2025 Forecast: Inflation Risk Tempers Outlook For 3-Year-Old Bull By: Jeffrey A. Hirsch & Christopher Mistal | December 19, 2024 | Email | Print

 

In our 2024 forecast we recapped our forecasts over the past several years versus how the market performed. We did pretty well. For 2024 we projected the bull market to continue with “More New All-Time Highs Anticipated,” and the potential for above average gains of 15-25%. We expected economic growth to slow and employment metrics to soften, but that it would remain healthy and that we would avoid recession. We also felt the Fed had a good shot at sticking the soft landing. 

 

With seven trading days left in 2024 and S&P 500 up 23.0%, our 2024 Forecast looks to be on track again. NASDAQ is up 29.2% while DJIA is up 12.3% and Russell 2000 brings up the rear with 10.1% gain year-to-date. Lagging small caps is a concern and along with keeping a close eye on our Santa Claus Rally and January Indicator Trifecta we will also be looking for broader market participation from the small cap sector. 

 

 

The Fed gave the market the quarter point rate cut it was expecting but made a concerted effort in its statement, quarterly economic projections, the dot plot and Chairman Powell’s presser to reset the market’s expectations for interest rate policy next year. We’ve been expecting less rate cuts moving forward into 2025 based on our reading of warming inflation data and bond market action since the September 50 basis point cut, most notably the 10-year Treasury yield breaking back above the 4.3% level in early November.

 

The Fed is concerned about inflation as it should be. We are too. It’s also encouraging to see them listening to and taking some cues from the bond market. This is how the Fed was designed to function, implementing guardrails on interest rates based on the bond market and economic data. This was the Fed walking the market back from its unrealistic rate cut expectations. It’s a classic under promise/over deliver posture.

 

We are not shocked by the Fed’s new slightly more hawkish posture. We have noted all year that the trend of cooling inflation would be difficult to sustain. We discussed it on our most recent members’ webinar earlier this month. The Fed has now admitted there is an issue with stubborn inflation, especially core inflation. We have updated our Inflation Projection charts of CPI and PCE here to help illustrate these inflation risks. 

 

Now that the Fed has made it clear that it will probably be cutting less with inflation warming, the market is set up to be pleasantly surprised if inflation settles down again and the Fed is able to lower rates further and faster toward a more neutral rate in line with annual GDP growth. 

 

 

 

Yesterday’s knee-jerk reaction selloff extended the Dow’s losing streak to 10 days, the longest daily losing streak since October 1974. This losing streak ended today. We posted this table below of Dow losing streaks on the December 17 blog. Historically, it took DJIA around 50 trading days to recover the losses accumulated during the past streaks. It may be a slow grind higher, but higher has historically been the subsequent path. Following the end of the previous eleven streaks, DJIA was higher 72.7% of the time 1-week, 2-weeks, and 1-month later. By the 3-month-after mark DJIA was higher 81.8% of the time with an average gain of 5.80% and a median advance of 7.59%.

 

Only two years were down three months later after these previous streaks ended. 1960 was Cold War related as Castro seized U.S. oil refineries in June-July of 1960 and the U.S cut off Cuban sugar imports. OPEC formed in September 1960 and the bear market bottomed on October 25 just ahead of John F. Kennedy winning the presidential election. World War II was raging in Europe in 1941 with the Germany invading Russia in June with many major battles waged throughout the second half of 1941. After Pearl Harbor was bombed on December 7, 1941, the multi-year bear continued lower until it bottomed in April 1942 once the USA entered the war.

 

Odds still suggest we are in store for a Santa Claus Rally and the continuation of the bull market. After the gains we have logged this year a bout of profit taking and a little fear is understandable and perhaps a healthy removal of some of the froth in the market and sentiment.

 

 

 

Despite the recent selloff the 4-Year Cycle and general market seasonality remain on track. The pullback has reverted the Dow back toward the mean though it remains above its cycle and election average gains. As we move into 2025, we will reset this chart to include the last four years of data and begin tracking 2025 and the next cycle. 

 

 

The chart below of the S&P 500 Seasonal Pattern for Post-Election Years appears on page 11 of the 2025 Almanac. It shows the basis for our annual forecast base case scenario with all but one line exhibiting solid gains for 2025. The Incumbent Party Losses pattern highlights the risks a change in party can have on the post-election year. If the market stays positive through January (think January Barometer) as the top four seasonal pattern lines do, we should be in good shape for 2025, notwithstanding some choppiness and pullbacks along the way as the market navigates the new administration and the new regime at the Fed.

 

We suspect Trump 2.0 policies will be supportive of the market and business and likely stir the animal spirits. Tariffs are likely to be used as a negotiating tactic to get folks to the table quickly. We have seen some of this already by the many world leaders who have visited and communicated with President-elect Trump over the past several weeks. He will likely employ his traditional “art-of-the-deal” shock and awe style to get people to the table to work on problems expeditiously. 

 

But as our research shows the midterm elections are usually tough on incumbents with their party prone to losing control of Congress – and the republican majorities in the next Congress are quite thin. So, he has about a two-year window to get his agenda implemented before the midterms. He is unlikely to pursue any policy that jeopardizes the prospects of ensuring he has a legacy of economic prosperity, a bull market and global stability. There will be successes and missteps and that will keep the market on its toes next year.

 

 

 

Economic activity remains resilient with GDP growth at 3% or better the past two quarters and is projected to come in around that level for Q4 2024. Let’s turn to our Four Horsemen of the Economy chart which depicts DJIA, Consumer Confidence, our inflation chart showing 6-month exponential moving averages of CPI and PPI and the unemployment rate overlaid with the recession bars. Note that we include the 2022 Q1 and Q2 recession we deem transpired based on the pre-Covid definition of two back-to-back down quarters of GDP. 

 

The lead horse of our Four Horsemen of the Economy is The Dow Jones Industrial Average. And while Papa Dow has lagged the S&P and NASDAQ and had some issues recently (great timing on adding Nvidia) it is still in a solid uptrend and not far off its all-time high hit earlier this month. Most of today’s gains in early trading were reversed but the Dow managed to post a gain and end its daily losing streak at 10 days.

 

Consumer Confidence pulled back earlier this year but remains in its uptrend since the 2022 lows. Holiday shopping was robust this year as you can see from the recent uptick in the ConCon chart. Inflation is still on people’s minds as prices of many staples remain significantly higher than they were just a couple years ago. But it does not seem to be curtailing consumer spending across the board.

 

Our inflation projection data discussed above highlights the risks over the near term should inflation heat up again. But looking at our inflation chart of the 6-month exponential moving average of CPI and PPI, consumer prices as measured by CPI remain in a downtrend, though producer prices (PPI) have ticked up this year. Definitely an important trend on our radar.

 

Also concerning is the uptrend in the Unemployment Rate this year. Recent labor market data points have been stable, but if that changes and Unemployment picks up along with inflation and they both trend higher that would also be concerning. But for now, Unemployment Rate remains historically low and the Fed remains accommodative. 

 

 

 

After closing above 45000 for the first time ever on December 4, DJIA fell into a 10-trading day losing slump. DJIA has endured a consecutive daily losing streak of this duration or longer just six times going all the way back to 1901. The last streak of similar duration was an 11-day streak that ended in October 1974. Total losses during DJIA’s recent losing steak were on the mild side until yesterday, December 18, when it dropped 1123.03 points (–2.58%). DJIA has now fallen below its 50-day moving average (1) but remains above its key 200-day moving average. Bullishly, DJIA uptrend from its October 2023 low remains intact.

 

Both the faster and slower moving MACD indicators applied to DJIA have been negative (2) since the close on December 9, confirming the loss of positive momentum in the near term. Due to the duration and magnitude of recent declines, both MACD indicators will likely remain negative longer even if DJIA does reverse course.  

 

 

Prior to the start of December, DJIA had recorded just six Down Friday/Down Monday (DF/DM) occurrences in 2024. With two full weeks of trading completed in December, DJIA has recorded two more DF/DMs (3) bringing its total to eight, which if this number holds, will still be below its historical average going back to 1995 (2025 STA page 78). December’s back-to-back DF/DMs are the first since June 2023. Back then DJIA went on the log gains in four of the five following weeks before correcting through August, September and October.

 

Despite DJIA’s recent woes, S&P 500 (4) and NASDAQ (5) have held up better mainly due to tech-share resilience. Coming into this week, NASDAQ had only declined twice during the past fourteen weeks and was up four straight weeks. If the market can come to terms with the Fed’s new outlook on rates quickly, and tax-loss selling/profit taking abates, then the recent pullback appears like a fair setup for a Santa Claus Rally to close out 2024 and kick off the New Year.

 

Weekly market breadth data has been deteriorating in December. Even with gains by NASDAQ during the first two weeks of December (and S&P 500 during the first week), Weekly Decliners have outnumbered Weekly Advancers the past two weeks (6). Looking back one year ago, a similar situation occurred in late December and early January but that did not stop the market from advancing for 5 weeks straight starting the second week of January 2024.

 

The market’s push to new all-time highs in early December was not accompanied by an expansion of new 52-week Highs. Instead, New Highs were declining and New Lows expanded (7). At a minimum it would be encouraging to see the number of New Lows stop growing and retreat. That may not happen until next week.

 

The writing was on the wall and in the data. Recent CPI and PPI readings were warm, and the 30-year Treasury rate had been trending higher (8) along with the 10-year Treasury Yield. Tomorrow’s PCE reading is also likely to signal the same, inflation’s retreat has slowed/stalled out. If PCE is inline or better than anticipated, the market could easily switch gears back to expecting more, rather than less, rate cuts from the Fed in 2025.

 

 

 

As we present our outlook for 2025 let’s remember not to overreact to the big selloff yesterday, the Dow’s losing streak and the Fed resetting expectations. In our view rate cuts are not necessary, but the Fed promised them to the market so walking back those expectations is not such a bad idea. Ask yourself what has changed materially or economically since the Fed’s announcement yesterday? Not much other than the dot plot and the Fed’s posture and rhetoric. 

 

Yes, it will be important for the market to resume its rally in short order and for December yearend seasonality to kick in as well as small caps to get out of their funk. It has been a huge year, and the market has come a long way over the past two years so some profit taking here is not unusual. Our January Indicator Trifecta, which incorporates the Santa Claus Rally, the First Five Days and the January Barometer are likely to prove critical this year.

 

Base Case: 65% Probability – Bull market tacks on average market gains of 8-12% with pullbacks in Q1 and Q3. Choppy trading as the market navigates change in Washington and the Fed trying to balance inflationary forces with sustained economic growth and a stable labor market.

 

Best Case: 25% Probability – Trump administration proves effective with few missteps. Inflation remains contained and U.S. economy continues steady growth without overheating or stalling. Geopolitics cools. Goldilocks scenario. More of a recent post-election pattern as the best year of the 4-year cycle since 1985 (page 11, Stock Trader’s Almanac 2025). Above average gains or 12-20%.

 

Worst Case: 10% Probability – Old school weak Republican President post-election year performance (page 28, Stock Trader’s Almanac 2025). Trump administration and Republican Congress implement to many drastic measures. Inflation spikes, economy cools, rates higher for longer and stubborn global turmoil. Teetering on bear market recession territory. Flat to negative full-year performance with broad losses across most asset classes.

 

While we are concerned about inflation, valuations and the older weak post-election patterns, we expect the bull market to continue through 2025, though it will likely be a much bumpier ride than it has been the last two years. Happy Holidays & Happy New Year, we wish you all a healthy and prosperous 2025!