The U.S. economy is walking a tightrope in early 2025. After a strong stock market rally in 2024, recent signals suggest things may be cooling down—at least for now.
Stock Market Outlook: Tapping the Brakes
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While the foundation for stock market strength was strong at the end of 2024, it has grown fragile within the last month. We anticipate we will soon make several changes within our clients’ portfolios in light of the evolving economic and market data.
What’s Changing
- Momentum is Weakening: The S&P 500 has slipped from overbought levels. In technical terms, this means the market had surged too quickly and was due for a pullback. A few important measurements of market momentum we watch closely have dropped below their bullish threshold for the first time since November 2023.
- Breadth is Thinning: Fewer stocks are participating in market gains. Indicators like the "Big Mo Tape," (shown below) which measures how many stock sectors are in uptrends, have been moving in the negative direction since the start of February. This is a sign that the recent rally may be losing steam.
Source: https://www.ndr.com/view/DAVIS250
- Global Markets are Following Suit: The percentage of global markets (from the MSCI ACWI Index) trading above their 50-day moving averages has fallen below 50%. This is both a technical signal and a reflection of softer economic activity worldwide.
These shifts in data suggest that while the stock market isn’t falling apart, its foundation is weakening. We do not see a significant correction looming, but do anticipate volatility remaining elevated, especially following the exceptional returns in ’23 and ’24. Markets may be more challenging to navigate throughout 2025 for many investors. Our internal risk management disciplines may necessitate an adjustment to reduce or reallocate equity exposure in the future if the data continues its current trend.
- Too Much Dependence on a Few Stocks: As of January 2025, the top 10 stocks make up nearly 40% of the entire S&P 500. That's the highest ever. If those stocks stumble, the broader market could follow.
- Tightening Government Policy: Government spending has been a big economic driver since the pandemic. In second presidential terms, however, it's common for presidents to tighten the purse strings-potentially reducing support for markets.
Economic Picture is Evolving
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Despite stock market jitters, the US economy is holding steady:
· Job market is strong: Unemployment claims are still low, indicating steady hiring.
· Housing Market is Mixed: Existing home sales bounced back from a weak January, but high mortgage rates are still weighing on the real estate market.
· Manufacturing has cooled but remains solid: Factory output reports indicate slowing activity, but employment in the sector has actually risen recently.
· Inflation Pressures: Input costs are climbing again, but business optimism suggests that the expectation is this will ease over time. Jerome Powell, the Chairman of our U.S. Federal Reserve Bank, recently held interest rates steady, telling markets he’s happy with the trajectory of inflation for now.
Overall, these trends suggest a more moderate level of economic growth in 2025 but no immediate signs of recession.
The Takeaway
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· Stay Diversified and Nimble: While stocks still have potential, the rally has definitively weakened, and risks are on the rise.
· We are on the lookout for a real rally. A healthy rebound from the latest stock market struggles should be broad, not just driven by a few tech giants.
· Watch Government Policy: Fiscal tightening could change the economic landscape later in the year.
The economy is not crashing, but the stock market is flashing yellow. After a robust run, it’s now slowing, with uncertainty surrounding inflation, global growth, and government policy
In short: We believe it’s prudent to remain cautious—but not panicked. The market is looking for its footing, and while that may take time, history shows that strong rallies often follow oversold periods. We will continue to be patient, selective, and ready for whatever comes next.