The Good and The Bad of the Upward Trends

Because the economy consists of and is operated by humans, sentiment is an important driver of growth. Since the November 2024 election, the mood of the financial markets and the economic environment has soared to new heights. However, such euphoria ultimately needs to be supported by fundamental realities in the form of improved borrowing conditions, increased M&A activity, a thawing housing market, and a robust venture environment. With the inauguration of Donald Trump on January 20, 2025, the countdown has begun.

• A new power dynamic: Since Donald Trump’s Presidential win in early November and the subsequent Red Wave in Washington, the market sentiment has shifted decidedly toward unmitigated optimism. There are hopes for deregulation and the extension of the 2017 tax cuts, and a general business-friendly environment. However, details remain elusive. The uncertainty surrounding tariffs and a razor-thin Republican majority in Congress may impact the current sentiment.
• Inflation and Fed policy: Inflation has reemerged as a concern, especially as many economists worry that tariff policies may apply upward pressure on prices. Renewed attention on inflation means potentially higher interest rate policy from the Federal Reserve. During their December 2024 meeting, the Fed revised their 2025 policy outlook from four cuts of 25-bps each to only two cuts. This change of posture represents a Fed that is still wary of price stability and is willing to keep rates higher for longer, which will impact everything from consumer lending, residential and commercial real estate, and valuation, to M&A activity.
• Priced for perfection? As of January 17, 2025, the forward 12-month price-to-earnings ratio for the S&P 500 Index is 21.6x, a high multiple from a historical perspective and above the 10-year average of 18.2x.¹ As markets tend to revert toward the median over time, the high valuation profile of the benchmark index is a source of anxiety for investors. However, the market is buoyed by optimism around the new administration and its business-friendly stance. As details of the new economic policies and executive orders emerge, the blanket enthusiasm may correct itself in the form of a public markets price adjustment.
• Credit markets: Even with the Fed’s more hawkish outlook on rates, the investment grade and high yield new issuance markets have been strong to start the year. As long as the public equity market sentiment remains positive, the credit markets are expected to perform well since they sit higher up on the capital stack. However, as the option-adjusted spreads get tighter, the risk / reward aspect of credit investing becomes less attractive. If we get a correction in the public equity space, we may see spreads widening, and investors may find a window of opportunity for better returns.

Investors in the public markets are starting 2025 with robust optimism about the coming year. But there are reasons to be cautious, especially in light of the new administration’s yet unknown economic and geopolitical positions. The first one hundred days of the Trump administration will be important to watch for details that will define the White House’s policies. In addition, the topics of inflation and interest rates are still an important determinant of financial market activity, and the future trajectory of rates remains to be seen. Under these conditions, a dose of skepticism may be prudent as realities of fundamentals adjust the lofty expectations of the year ahead.

¹ FactSet Earnings Insight, 1/17/2025

Investment advisory services provided through CBIZ Investment Advisory Services, LLC, a registered investment adviser and a wholly owned subsidiary of CBIZ, Inc.