Summary

The Argus Research 2025 Outlook On December 4, 2024, the Argus team presented the ‘Argus Research 2025 Outlook’ in webinar form. Below we include synopses of the commentary from Argus President John Eade, Director of Economic Research Chris Graja, CFA, Fixed Income Strategist Kevin Heal, and Director of Research Jim Kelleher, CFA. 2024 Review While our focus is on our forecasts for the year ahead, a quick look backward shows that U.S. stock indices are all positive for 2024, including the S&P 500 being up over 25%. In 2024, most major indexes are advancing in lockstep, with the gains in the Nasdaq and the S&P 500 within a few percentages points of each other. That stands in contrast to 2023, when the Nasdaq Composite index rose nearly twice as much as the S&P 500, and the DJIA was deeply lagging. Within the S&P 500, seven of the 11 U.S. sectors are up at least 20% for the 2024 year. In 2023, the S&P 500 also rose more than 20%. But only three sectors were strong in 2023, while the other eight sectors had an average gain of less than 4%. In our view, this sector breadth is the most important feature of the 2024 U.S. stock market, which we think is a very positive indicator for 2025. In December 2023, we provided base case, bull case, and bear case scenarios for 2024. The 2024 year has unfolded mainly in line with our base case, in that inflation fell below 3%; the Fed began to cut rates, though in the fall rather than our forecast for mid-year cuts; recession was avoided; and a victor was declared in the presidential race. But the market did much better than our base-case forecast of 8%-12% rise in S&P 500: the S&P 500 in 2024 is up more than twice as much as we indicated in our base-case forecast. Director of Economic Research Chris Graja, CFA: The U.S. economy is healthy and growing, powered by resilient, employed consumers. November nonfarm payrolls increased by a better-than-consensus 227,000. The strong growth reflects bounce-back from the severe hurricanes in October and the resolution of the Boeing machinists’ strike. The three-month average gain of 173,000 is close to the 12-month average of 184,000. Unemployment ticked to 4.2% from 4.1%, and wages grew annually by 4% – faster than annual growth in inflation. The job market is cooling, in the way the Fed intended. There are still more job openings than people who are unemployed. Fewer people are being hired. However, also fewer people are quitting or switching jobs, and higher-paying jobs are now harder to find. This change in the U.S. labor market is bringing us close to the kind of balanced level that supports the Fed’s dual mandate of 2% inflation and maximum employment. The Fed’s unemployment forecast (in the ‘Dot Plot’ report) is 4.4% in 2025 and 4.2% over the long term. Economists surveyed by the Philly Fed expect 4.3% unemployment in 2025. Unemployment in a range of 4% – 4.5% is near ‘full employment,’ which is the lowest rate consistent with price stability. New academic research indicates that full employment is consistent with a 4.3% unemployment rate in the U.S. Based on Federal Reserve data that examines population growth and the labor force participation rate, monthly payrolls growth of about 100,000 are needed to keep the unemployment rate at 4.2%. As job growth slows, we are not looking for extensive layoffs. Skilled workers are scarce, severance is expensive, and the economy is growing. In this environment, we expect employers to hang onto their workers and ride out any periods of softer economic growth. During the calendar fourth quarter, we expect holiday sales to rise about 3% this year to nearly $1 trillion. Consumers are employed, and the election is settled. That stability is good news. More affluent consumers are doing very well. The top third of households by income account for about 55% of spending. The unemployment rate for college graduates is just 2.5%. These consumers are also enjoying stock market gains and tend to have a mortgage locked in at a low rate. Lower-income consumers are struggling. Even though the year-over-year inflation rate on food is low, prices are 25% or more above pre-pandemic levels. The bottom third by income account for only 15% of spending. This group has relatively strong employment levels and we look for their spending to grow this holiday season. For all consumers, momentum from U.S. GDP growth and rising real disposable income are good signs for holiday spending. Three categories really drive holiday quarter spending. We forecast grocery spending to rise 2%-plus, general merchandise spending to rise 3%-plus, and online spending to rise more than 6.5% from last year. In January, U.S. consumers typically spend less as they face their credit card bills from the holiday. The Proxy Funds Rate uses 12 financial variables (yields & spreads) to translate the full range of Fed policy actions including the Fed’s forward guidance of the funds rate. We believe this is a reliable indicator as it captures mortgage rates and bond yields. The decline in the proxy funds rate from fall 2023 to fall 2024 signals a substantial easing in financial conditions. The proxy funds rate is up 80 basis points (bps) since mid-September, recalibrating as the market pivoted from recession fear (due to the triggering of the Sahm Rule) to recognition of the difficulty in eliminating the final percentage point of inflation growth. A higher proxy rate may temper growth and remaining inflation. The U.S. Dollar Index (DXY) is up 4% in 2024 and currently is about 20% above historical averages. The dollar rallied this fall with higher Treasury rates and President-elect Trump’s pro-growth platform. The relative strength of the U.S. economy and demand for U.S. investments may keep the dollar firm in 2025. If we see slower U.S. economic expansion, that could weigh on the dollar in 2025. Productivity is the key to sustainable growth. Innovation is driving productivity, and Investment is fueling innovation. These are all good indicators for the U.S. We expect 4Q24 GDP to grow +2.8%, resulting in 2.6% U.S. GDP growth for 2024. For 2025, we look for 2.0% GDP growth with a stronger second half. We expect the U.S. economy to continue to avoid recession in 2025. Fixed Income Strategist Kevin Heal: Inflation measures are trending towards the Federal Reserve’s stated goal of 2%, but even the Fed has noted that it will be a bumpy path. Overall prices are not declining; they are just not rising as fast as they were in 2022 and 2023. At Argus, we look at 20 different price indicators. On average, these indicators show lower goods prices partly offset by higher services prices. The latest data shows increases in auto and home insurance rates due to extreme weather events, and higher asset management fees due to stock market gains. Shelter costs, which reflect up to one-third of total consumer spending, are also still on the rise. After raising the federal funds rate to the 5.25%-5.50% range between 2022 and mid-2024, the Fed has cut rates twice in 2H24, by 50 bps in September and 25 bps in November. The 50-bps cut was a response to an uptick in the unemployment rate, while the 25-bps cut signaled the Fed’s confidence in its pivot to accommodative policy even amid slightly stronger economic data. We expect an additional 25-bps cut at the December meeting. We expect the Fed to pause at the January meeting with the impending presidential inauguration. We then anticipate three more rate cuts in the first half of 2025. Assuming those cuts are made, we anticipate no further cuts in the second half of 2025. We expect the fed funds to settle around the 3.5% level. Assuming inflation settles around 2.00%-2.25%, that would indicate a real fed funds rate around 1.25%-1.50%. U.S. current deficit is approximately $36 trillion and growing. During the presidential campaigns, neither candidate focused on measures to balance the budget. President-elect Trump’s Department of Government Efficiency (DOGE) is designed to reduce wasteful government spending. Even if DOGE is able to cut $2 trillion, this would result in only 5% savings. But it would be a start. In fall 2024, the U.S. Treasury curve finally turned positive after spending two years inverted, meaning short-term rates were higher than long-term rates. The 10-year/2-year spread, which had been as low as negative 1%, has been positive since the initial 50-bps rate cut in September. We look for the slope to steepen further in 2025 as shorter-term rates head lower and longer-term rates remain near their current levels. We expect mortgage rates to remain near their current levels, as they are primarily based on the longer end of the curve. Director of Research Jim Kelleher, CFA: Heading into the 3Q24 earnings season, our forecasts for S&P 500 earnings from continuing operations were $247 for 2024, $265 for 2025, and a preliminary $290 for 2026. Our 2024 forecast has not changed, but in mid-December 2024, we raised our 2025 and 2026 forecasts for S&P 500 earnings from continuing operations. For 2025, we raised our earnings forecast to $276 from $265. Our revised 2025 forecast models full-year EPS growth of about 12%. Our increased optimism toward 2025 earnings reflects expected better performance for three sectors that were negative in 3Q24: Energy, Materials and Industrials. We expect the Energy sector’s annual earnings decline to moderate in 4Q24 and 1Q25 before swinging to a modest positive in the second quarter. Materials and Industrials could swing to positive comparisons more quickly, possibly as soon as 4Q24 (Materials) and 1Q25 (Industrials). The strongest EPS growth in 3Q24 came from Communication Services and Information Technology. Utilities, which posted strong EPS growth in 2024 year-to date, is forecast to see more moderate earnings growth but to remain above the long-term average. Other sectors forecast to grow EPS above their long-term averages in 2025 include Financial, Healthcare, Consumer Discretionary, and Consumer Staples. For 2026, we raised our forecast for S&P 500 earnings from continuing operations to $307. Our revised forecast models full-year EPS growth of about 11%. In 2026, we look for a slightly more moderate growth outlook due to more challenging comparisons. We expect the AI transformation to continue to drive growth in Communication Services, Information Technology, and Consumer Discretionary. We look for growth to slow in defensive sectors but to pick up in Energy. One notable feature of the strong 2024 performance has been sector breadth and less reliance on the usual growth-sector leaders. As 2024 progressed, growth sectors such as Information Technology and Communication Services began to stall out, ceding leadership to defensive, cyclical, and interest-rate-sensitive sectors. The S&P sector map at the end of June 2024 looked like a less-extreme version of the sector map at mid-year 2023. Although just the two traditional growth leaders were ahead of the market at mid-2024, several sectors were up nicely — including Financial, Utilities, Energy, Healthcare, and Staples. In the second half of 2024, the rotation toward new favorite sectors intensified. Six sectors are doing better than the market in the second half of 2024, and six sectors are also beating or tracking the broad market for all of 2024 to date. In 2023, almost all growth came from just three sectors. The rotation toward new favorite sectors includes a particularly intense pivot toward perceived beneficiaries of a lower-interest-rate environment. These include Financial, Utility, and Real Estate. This much more-balanced market has also led to favorable PEGY ratios in multiple sectors. Healthcare, Communication Services, and Financial offer attractive growth/value balance. We believe sector rotation, which intensified in the second half of 2024, lays the groundwork for a more balanced and thus more stable market in 2025. It also positions stocks for further gains as investors cash out winnings in growth sectors and redeploy them into now-rising cyclical, interest-rate-sensitive, and defensive sectors. Our stock/bond asset-allocation model is indicating that stocks are the asset class offering the most value at this market juncture. Our model factors in real-time index price levels and forecasts of short-term and long-term government and corporate fixed-income yields, inflation, stock prices, GDP, and corporate earnings, among other factors. The output is expressed in terms of standard deviations to the mean, or sigma. The mean reading from the model, going back to 1960, is a modest premium for stocks, of 0.14 sigma, with a standard deviation of 0.97. In other words, stocks normally sell for a slight premium valuation, which they did for most of the 2022 and 2023. The current valuation level now is a 0.14 sigma discount for stocks, reflecting in large part the move lower in long-term interest rates. Other valuation measures also show reasonable multiples for stocks. The current forward P/E ratio for the S&P 500 is approximately 21-times, within the normal range of 15-24. The two-year forward P/E based on our estimates and the current S&P 500 price level is within 4%-7% of the trailing five-year P/E for the S&P 500. The EPS yield of 4.1% minus the ‘real’ 10-year Treasury bond yield (remember, real yield is nominal yield minus inflation) is richer than average but not at a level signaling overvaluation. The ratio of the S&P 500 price to an ounce of gold is now 2.3, within the historical range of 1 to 3. We expect the results from our stock-bond valuation model to tilt even more toward stocks as interest rates head lower into 2025 and EPS growth picks up. The VIX Volatility Index tended to trade in the 20 or above range for most of the 2020-22 period, as investors navigated the pandemic, the supply-chain crisis, and spiking inflation. Outside of a spike to the high 30s in August, the VIX has been below 20 for most of 2024. The index is currently in the 13-14 range. The reduction in VIX is consistent with bull markets, which tend to be periods of reduced market volatility. When we examine the risk environment, we see that some of the old risks are fading away. These include supply chain, inflation, Russia, recession, and restrictive Fed policy. One of last year’s new risks, concentration, has now faded amid the rotation and favorable sector breadth discussed above. A lingering concern is inflation, as eliminating the final percentage point of inflation on the way to the 2% Fed target has proved challenging. The incoming administration has proposed fiscal policy and tariffs that risk the recurrence of inflation; as a possible offset, less regulation could reduce inflation. China is a risk from both an economic and geopolitical perspective. The economic risk occurs if this massive market remains stuck in the malaise that has existed since the zero-tolerance COVID lockdowns. The geopolitical risk occurs if the government decides to distract from economic struggles by attacking Taiwan or