The U.S. economy has exhibited unusual strength and resilience, largely due to the flood of fiscal spending by the Biden Administration. This additional stimulus was layered on top of pandemic-related Covid relief spending and Federal Reserve policy support. Still, the economy was far from perfect. Inflation proved slow to recede, leading the Federal Reserve to embrace a higher-for-longer approach to interest rates. The housing and manufacturing sectors continued to struggle under the weight of high borrowing costs, and consumers with credit-card debt, mortgages and other loans saw rising delinquency rates.
We would argue that the Biden Administration’s multiple stimulus programs have exacerbated inflation and will ultimately be recognized as harmful to the U.S. and global economies, particularly as the Federal Reserve puts its interest rate cut program on hold. High interest rates are already constraining specific sectors like housing and manufacturing, despite GDP figures suggesting a strong economy.
Economic growth and relatively full employment are poised to erode more rapidly in the coming months as the incoming Trump Administration implements policies such as increased tariffs, government expense rationalization, and stricter immigration measures, which are likely to further elevate inflation and slow the economy, at least initially. Corporate earnings growth trends, which have been robust, may decline sharply as early as Q2 2025. While Trump’s tax cuts may provide some support, they are unlikely to offset the negative impacts of his other policies.
The inevitable conclusion is that the U.S. stock market will find 2025 a challenging year as supporting fundamentals weaken materially. Following back-to-back 20%+ returns in 2023 and 2024, a pullback could surprise to the downside, potentially triggering a short-lived but powerful bear market. Investors may find it difficult to hold through such volatility.
Economic Resilience and Cracks:
As Bloomberg reports, the U.S. economy outperformed its G-7 peers in 2024, driven by strong consumer spending and wage growth. Though consumers are still holding up, some of the main drivers of that remarkable resilience lost steam this year. Americans have mostly exhausted their pandemic savings and have generally been putting aside a smaller share of their incomes each month. Lower-income households showed signs of financial strain, with rising credit delinquencies.
Consumer spending has also been increasingly driven by higher earners who are enjoying a so-called wealth effect from gains in housing prices and the stock market. That’s taking place while many lower-income consumers are relying on credit cards and other loans to support their spending, with some showing signs of financial strain like higher delinquency rates.
Hiring decelerated throughout the year and the unemployment rate edged higher, triggering a popular recession indicator. Moreover, the number of job openings declined and the unemployed are increasingly having a harder time finding new jobs.
Inflationary Pressures:
Inflation has proven slow to recede, with the this “higher-for-longer” inflation environment may limit the Fed’s ability to cut rates further in 2025. Progress toward the central bank’s 2% inflation target
has stalled in recent months following a swift decline in 2023 and additional progress in the first half of 2024. One of the Fed’s preferred inflation metrics — the personal consumption expenditures price index excluding food and energy — rose 2.8% in November from a year ago. This “higher-for-longer” inflation environment limits the Fed’s ability to cut rates further in 2025.
Sectoral Weaknesses and Corporate Earnings Risks:
The housing market and manufacturing sectors remain under pressure from elevated borrowing costs and weak demand. Mortgage rates, which fell to a two-year low in September, have been approaching 7% again on expectations that the Fed will take longer to cut. Contractors continued to offer incentives to lure buyers, including so-called mortgage interest rate buy downs and payments on their behalf, as well as occasional price cuts. This pressure is likely to weigh on corporate earnings, which may decline significantly by Q2 2025 after a strong 2023–2024 period. While sales have stabilized somewhat this year, they remain below pre-pandemic levels. In the resale market — which accounts for a majority of home purchases — the National Association of Realtors anticipates the 2024 sales pace came in even lower than last year, which was already the worst since 1995.
The manufacturing sector was another victim of elevated borrowing costs. Investment in new structures was hindered by high rates and weaker demand abroad, and many firms shed jobs in an effort to save costs. Durable goods manufacturers subtracted from payrolls in all but one month this year. President-elect Donald Trump’s economic agenda could also weigh on the sector in 2025. Though Trump has promised to boost domestic manufacturing, his plans to impose higher tariffs, deport millions of immigrants and cut taxes could push up inflation and constrain the labor market, as well as to possibly disrupt supply chains. In this environment a rise in capital spending by US manufacturers is seen as unlikely next year amid uncertainty.
Market Dynamics and Valuations:
The AI-driven stock market rally of 2023–2024 has elevated returns to higher-than-normal levels, with many large AI companies sporting extreme valuations. The sustainability of this performance is increasingly questionable, as the “AI craze” may not deliver enough returns to justify the risk or valuation premiums. This stage of the bull market, characterized by a potential “last gasp” 5%–10% return, is historically the most dangerous for investors to chase, as it often precedes sharp corrections.
Conclusion:
The weakening economic fundamentals, combined with overextended market valuations and an exhausted bull market rally, suggest that 2025 may bring a challenging environment for the U.S. stock market. The anticipated pullback could result in a powerful bear market, though likely short-lived, testing investors’ ability to hold through the volatility. With many AI-driven investments at extreme valuations and diminishing upside, the market may struggle to find new drivers for growth, leaving investors exposed to heightened risks as the economy transitions into a slower growth phase.