by Jurrien Timmer, Director of Global Macro, Fidelity Management & Research Company
A happy new year to all you WAARiors out there, and I am looking forward to learning from you again 2025.
Price Discovery Never sleeps, not Even on New Year’s Eve
In technical analysis, markets are often seen as trending or consolidating. Those are two of the stages of price discovery, which is a process that is happening 24/7. I think of price discovery as the collective unconscious (and conscious) of the global capital market ecosystem.
Trending phases are when material new information is coming in (the AI boom is a good example of this). Consolidation phases are when the markets have digested said information and are waiting for new signals (an election or FOMC meeting, for instance).
The trending part is simple enough to understand (not that anything is simple), but the consolidations are trickier. Technicians tend to put these patterns into two categories: continuation patterns and reversal patterns. What we call triangles or wedges or head-and-shoulders are either pauses in the prevailing trends or potential inflection points. Market math says that historically two thirds of the time these chart patterns have been continuation patterns, i.e., they resolved in the direction of the prevailing trend. It’s the other third that we have to watch for.
With both the cyclical and secular bull market for equities getting more mature (27 months and 15 years, respectively), and potentially facing more headwinds from rates and inflation in 2025, let’s review where we stand on the matter of price discovery now that 2024 is in the rearview mirror.
The Year That Was
On the surface, the markets ended 2024 much the same way that they began, with the US mega growers in charge, along with Bitcoin and gold, and with bonds and commodities at the bottom. Whether 2025 will be the year that flips these polarities around is something that we will all be spending many hours on in the coming months.
Orange is The New Yellow
Looking at 2024, we see that Bitcoin seems to have stolen the show, reaching $100k in December.
Meanwhile, gold’s stellar performance in 2024 (coming in ahead of the S&P 500) is especially impressive considering that it’s the most negatively correlated asset out there.
Not Garden Variety
The cyclical bull market is now 27 months old, and on the surface, it looks like a garden variety bull market. But looks can be deceiving.
Narrowing Breadth
While the cap-weighted S&P 500 climbed an impressive 25% in 2024 (the second 20%-plus increase in a year), there was a significant loss of breadth in the final weeks of the year. As of year-end, only 28% of stocks outperformed the index, very close to the 26% in 2023. After a significant broadening throughout the year, this is not what we want to see.
In fact, as of December 31st, only 57% of stocks in the S&P 500 were above their 200-day moving average. This is well below the 75-80% that was in place for most of 2024. The equal-weighted index rose 13% in2024, close to half of the cap-weighted index. The Russell 2000 index rose 11.5%.
Sector Dispersion
Sector-wise, 2024 was a familiar story, with tech, coms, and consumer discretionary in the lead, and materials, energy and real estate lagging behind. To the untrained eye, perhaps the biggest surprise is the strong performance from utilities, but the AI infrastructure theme is strongly at work there.
Continuation or Reversal?
This leaves us with the question of whether the above themes will continue into 2025. Given that trends in motion have tended to stay in motion (hence the two thirds rule for continuation patterns), I’m assuming the answer is yes. Having said that, we can see from the periodic table below that these trends have been in motion for quite some time now. Bitcoin and large growth (LG) on top, long-dated treasuries (LT) and commodities at the bottom.
If we convert the above annual changes to 5-year CAGRs, we can see the prevailing trends even more clearly. At some point, mean reversion will kick in, and it will likely be fierce, but when and from what level remains an elusive question.
Parabolic
Timing tops (and bottoms) is always a low-percentage undertaking, and in the case of the Mag 7 it has been especially so. The chart below shows how similar the slope of the ascent has been for NVDA and BTC in 2024, CSCO in 2000, and RCA in 1929. It would suggest at first glance a parabolic curve like that would look like a bubble ready to burst. Yet, Bitcoin has already rocketed to new highs. As Peter Lynch always said: “most people water the weeds and cut the flowers - when they should do just the opposite.”
Cycles
With a new Administration coming in, a new Presidential cycle is underway. Historically, years 1 and 2 have tended to be the slowest of the four, but we are hardly living in normal times, so who knows? If we combine the annual seasonal pattern, years 1 and 2 of the Presidential cycle, and “year 5” of the “down mid-term” cycle, we get the roadmap below. It suggests an up but below-average year for stocks. Given what I am expecting from the rate side, plus what seems to be a uniformly bullish consensus out there, such a scenario seems quite plausible. Perhaps 2025 will be more like 2018 than 2017, with volatility coming entirely from the valuation side.
Secular Trend
As for the secular bull market, I still believe we are in the later innings but that the bull market remains intact for a few more years. The 10-year CAGR for the nominal S&P 500 index is +13.0% as of December 31st, very close to what the CAPE model would have predicted 10 years ago (+14.8%). The model suggests that these double-digit returns could prevail for a few more years, before potentially reverting to the long-term mean and then below.
Earnings
With valuations having done much of the heavy lifting since the cyclical bull market began in 2022, the stock market’s trajectory in 2025 - and especially the Mag 7’s leadership - will likely come down to earnings. So far, the earnings picture looks healthy, with the calendar year 2024 estimate having been rock solid all year and the subsequent estimates showing healthy sequential gains.
Price follows earnings, and relative price follows relative earnings, so watching the relative earnings estimates for the Mag 7 and bottom 493 remains key. For now, the runaway train that is the Mag 7 seems to be justified by their relative earnings momentum, their 38x P/E-multiple notwithstanding.
Sentiment
Having said that, all this is well known, which is reflected in the sentiment data. Not only are most sell side strategists bullish, but the investor flows have been robust as well. It makes you wonder if the Red Wave has been mostly discounted before we even get to inauguration day.
Rates
My main concern for 2025 remains inflation and the prospect of a continued bearish steepener, led by fewer (or no) rate cuts than expected and ongoing increase in the term premium. We can see that the curve has now un-inverted as short rates have come down and long rates have risen.
My fear is that a reacceleration in the economy wakes up the inflation genie before it was ever put back in the bottle. If so, the TIPS curve is woefully complacent.
As for the Fed, it is rightly walking back from further rate cuts, until the disinflation trend of 2023 resumes. We can see from the different iterations of the Taylor Rule below that the downside momentum for short rates has ended for now. The Fed is in the right place at 4.25-50%, but further cuts are not justified until the inflation rate gets closer to target.
A Rising Wedge for Bond Valuations
As for bonds, the chart below of the “P/E” ratio for the 10-year shows what appears to be a clear continuation pattern. That suggests that new yield highs above 5% (or a P/E below 20x) may well be in store for 2025.
Term Premium
So far, the rise in yields in 2024 came entirely from an increase in the term premium and not from rising inflation expectations. If the unusual pattern of negative term premia during the 2010’s was the product of financial repression (QE and ZIRP), it makes sense that the risk premium should return to a more normal level in the 2020’s and beyond (150 bps?), now that the central bank’s heavy hand has been lifted just at a time when fiscal policy has become dominant.
Valuation Headwinds
If yields rise in 2025, especially north of 5%, the stock market will not like it. With the correlation between bonds and stocks now positive, and the Fed model back in charge, rising yields could act as a headwind for equities, at a time when valuations have reached the top 10 percentile of their historical range. Earnings seem fine, as they were in 2018, but the risk that the bullish momentum gets occasionally disrupted by rate tantrums.
Investment Clock
For now, we remain in the sweet spot of favorable financial conditions and growing earnings. That’s the upper left quadrant of the market cycle clock below. The risk for 2025 is that we move from top left to top right, with earnings growth remaining positive while financial conditions tighten up.
Perhaps the last few weeks of December were already a hint in that direction, with market breadth falling away and only the Mag 7 running the show. If so, rather than expecting a continuation of 2024’s “bullish broadening” momentum, perhaps in 2025 we should look for a repeat of 2018 (growing earnings and rising rates) or even 2023 (narrow absolute and relative leadership).
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Copyright © This information is provided for educational purposes only and is not a recommendation or an offer or solicitation to buy or sell any security or for any investment advisory service. The views expressed are as of the date indicated, based on the information available at that time, and may change based on market or other conditions. Opinions discussed are those of the individual contributor, are subject to change, and do not necessarily represent the views of Fidelity. Fidelity does not assume any duty to update any of the information.
