More Modest Expectations
The strong, broad-based rally in equities that we saw leading up to and after the Trump win was largely a relief rally built on the theme of a Trump administration that would be pro-growth, offering lower taxes and a less heavy regulatory environment. From early August through December 6th equities were up by 18% on the pending changeover in Washington to take place in January 2025. However, since early December the rise in interest rates has tempered the feel-good equity rally. What can investors expect as we look out over the next twelve months or so? The differences in Trump 2.0 compared to President Trump’s first term will be the subject of this market outlook.
On December 6th the 10yr Treasury was at 4.15% and has since risen to 4.65%. That’s a fairly large increase in just a month-and-a-half, signaling that the bond market isn’t convinced that inflation is under control and that the Fed’s rate cutting plans may be scaled back in 2025. Indeed, since December 6th equities have essentially been chopping sideways as the market continues to weigh the impact of higher rates and potential Trump policies. The move higher in rates seems to have stolen some of the thunder from the equity rally that led up to and after the election. We infer the bond market will act as a regulator on the stock market and the overall economy for that matter. The higher rates mean that the cost of raising capital for companies increases and it also means the average US consumer is impacted as well.
Mortgage rates have been firmly over 6% for over two years now and stand at about 6.9% today. The move higher in the 10yr note directly impacts mortgage rates and means larger monthly payments for home buyers and less money for discretionary spending. Mortgage rates were 4.00% at the end of 2019 before Covid-19. This move higher in mortgage rates has meant that existing homeowners with mortgages under 5% are disincentivized to move and are likely to stay in place. And in turn, this impacts potential first-time home buyers who are faced with a tighter housing market.
As well, credit card interest rates today stand at about 22%. This compares to about 15% in the fourth-quarter of 2019 before the pandemic. This 7% increase means that consumers that carry a balance from month to month are paying more each month in interest and this also means less money for discretionary spending. NerdWallet, in their recent 2024 year-end report, said that US households with revolving credit card balances were carrying an average of about $10,500. Capital One’s CEO said on the company’s fourth-quarter earnings call that they’re seeing more customers making just the minimum payment on credit-card balances instead of the full amount each month and that the proportion of Capital One customers making only minimum payments was also higher than pre-Covid19 levels.
The same NerdWallet report also showed that the average US household with automobile debt is currently carrying over $37,000 to finance their vehicle(s). The average five-year auto loan rate tends to be tied to the movements in the 5yr Treasury note, which stood at 1.67% at the end of 2019 and is at 4.43% today. This month, Edmunds.com listed the average car loan interest rate for December 2024 as 6.6% APR for new car loans and 10.8% APR for used car loans.
Inflation in the fourth-quarter of 2019 was at 2.3% on a YoY basis and stands at 2.9% today. This 2.9% is down from 9.1% in the second-quarter of 2022. More importantly, consumers today are still faced with higher food prices. Grocery prices increased by 1.8% on a YoY basis in December. This was the fastest pace in over a year according to the Labor Department data report released the previous week.
All of this being said, the US consumer continues to show resilience and a strong propensity to spend. US retailers report that the 2024 holiday season saw a 4% YoY increase in spending – this surpassed the National Retail Federation’s forecast of 2.5% to 3.5% (retail sales figures are not adjusted for inflation). And consumers continued to spend at the start of 2025 as reported by the largest US banks (JPMorgan Chase, Bank of America, and Cititgroup) in their fourth-quarter earnings calls. Credit card spending as reported for the month of January so far shows robust growth.
As we look at the equity market and the year ahead, the S&P 500 is currently trading at 22.5x. This compares to 17.3x in January 2017 when President Trump took office in his first term. And we’re coming off of two very strong back-to-back years of equity performance of 26.3% and 25% for 2023 and 2024, respectively. The S&P 500’s earnings yield is now at 4.44%. This means that the 10yr’s yield of 4.64% is attractive relative to the potential earnings yield on equities (and the 5yr Treasury at 4.45% is right there as well). In January 2017 the S&P’s earnings yield was at 5.78% and the 10yr and 5yr Treasuries were at 2.43% and 1.94% respectively. The point of this being that equities are now more highly valued relative to January 2017, so investors implicitly expect very solid economic and profit growth over the next twelve months. As a firm, we also still like the outlook for US economic growth over the next twelve months and we think equities still offer upside potential, reflecting the new administration’s pro-growth backdrop.
Note: The market’s reaction to China’s DeepSeek AI model demonstrates that technology innovations can occur at any time, and unexpectedly, and those surprises can significantly disrupt stock prices for competitors. According to reports, its AI models use fewer advanced chips and this puts into question the extent to which growth will continue for US suppliers of those chips (Nvidia, Broadcom, Marvell, and others). In addition, if it is the case that DeepSeek is using far fewer chips, the world may need a smaller data center buildout and those data centers could need less energy. Today, we are seeing shares in companies supplying equipment and energy to data centers also falling. Indeed, investors seem now to be questioning risky assets more generally as hopes for growth in the leading sectors potentially become more muted. Valuations of these companies embody significant growth for many years to come, so any decrease in growth forecasts will reduce multiples investors are willing to pay today. It is too soon to determine the veracity of the claims being made by DeepSeek regarding its underlying hardware usage. And even if proved true, imagine how much more powerful AI models would be using the vastly better hardware of the leading providers, including Microsoft, Amazon, and Google. Advances in the software for training and applying AI models would also lead to faster and more profitable adoption of AI applications. All this would bring clear benefits to firms and consumers who make use of AI in the future. The disruption to risky stocks today reinforces the value of our diversified approach to investing across ACM strategies.
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