Five for Friday - December 20, 2024

A Few More Things to Watch in the New Year

1. 2025

In our “2,025 Things For 2025” outlook note, we discussed the importance of A.I. as a key driver of the market’s long-term potential, and argued that investors will soon demand to see evidence that the hundreds of billions being invested in infrastructure (e.g., data centers) are starting to pay off. This is probably the most important question facing markets for the next several years, especially given the extent to which the S&P 500 is concentrated in Big Tech names. Per Strategas, a Baird company, the 10 largest companies in the S&P are now roughly 39% of its weight—a new high—and one could argue the 8 largest (Magnificent 7 + Broadcom) are all A.I. plays in one way or another. Mag. 7 earnings growth is expected to handily outpace the other 493 in aggregate, and consensus expectations for record S&P 500 profit margins are based in part on these companies continuing to innovate and grow. Getting out of the market due to Big Tech concentration worries would have been a huge mistake at any point over the last decade (and concentration has had little predictive power for the market’s returns) but on the whole, there’s little more important in 2025 than investors’ opinions on A.I. adoption and investment.

2. Rates

The Federal Reserve lowered interest rates by 25 basis points this week, bringing their 2024 total to 100 basis points of cuts. But in markets, eyes look ever forward, and the Fed’s outlook for 2025—just two rate cuts vs. a previously forecast four—was a minor surprise to markets (in fact, the median forecast among the FOMC’s members now doesn’t see four rate cuts until the end of 2026). We have been arguing for a while that the 2010-2021 interest rate environment was an anomaly and is unlikely to be repeated going forward—particularly if geopolitical unrest, trade/ immigration policy, etc. keep inflation above the sub-2.0% levels seen in the 2010s. A higher-for-longer rate environment has broad ramifications for savers (good), borrowers (challenging), and everyone else inbetween.

3. Inflation

While tariffs have been maybe the single most-discussed financial topic post-election, immigration policy is likely more important to the near-term outlook. As Strategas Chief Economist Don Rissmiller wrote, “While tariffs get a lot of headline attention, both U.S. political parties have used [tariffs] to some extent and the economy has continued to grow. Likely more worrisome would be restricting labor supply in an economy near full employment.” A PIIE study estimates that the deportation of 8.3 million unauthorized immigrant workers would cumulatively increase consumer prices 9.1% by 2028 (via a tighter labor supply leading to higher wages), whereas by comparison, an additional 10 percentage point tariff on all trading partners + retaliation would only lead to a 1.8% increase. The numbers can be debated ad nauseum, but the speed and magnitude with which immigration reform is pursued will be a key driver of inflation and rates in 2025.

4. Risk

Amid all of the December market pontification and 2025 outlook discussion, it seems an appropriate time for the evergreen reminder that true market risk comes from events that no one sees coming. Take the Covid-19 pandemic—this was one of the most significant market events of the last 100 years, and yet you’d be hard pressed to find a single 2020 investment outlook note that even mentioned it as a possibility. That is true risk, and it is ultimately managed by building a durable portfolio, remaining composed in the face of uncertainty, and controlling what you can control.

5. On this day

in 1946, Frank Capra’s “It’s a Wonderful Life” premiered in New York City. While seasonally timely given its standing as one of the best holiday movies ever made, it also finds itself in this investment note for its (still relevant…cough, Silicon Valley Bank, cough) portrayal of a bank run and its description of fractional reserve banking—“You're thinking of this place all wrong, as if I had the money back in a safe. The money's not here. Your money's in Joe's house, and then the Kennedy house…and a hundred others.” Worth a rewatch every December. Happy holidays, all.

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This is not a complete analysis of every material fact regarding any company, industry or security. The opinions expressed here reflect our judgment at this date and are subject to change. The information has been obtained from sources we consider to be reliable, but we cannot guarantee the accuracy. Market and economic statistics, unless otherwise cited, are from data provider FactSet.

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