The 2025 Economic Outlook
“We are accustomed to say that the markets are ‘barometrical’ or that they ‘discount the future’… The careful security holder’s eyes turn eternally toward the future.”
Laurence H. Sloan
Everyman and His Common Stocks:
A Study of Long Term Investment Policy (1931)
Building off strong momentum in the first quarter, markets ended the year up double digits, with the S&P 500 gaining 25.0%, the DJIA 15.0%, and the NASDAQ 29.6%1 (Figure 1). For the first time since 2021, the S&P also generated a positive return in all four quarters of the year, largely driven by the momentum of the “Magnificent Seven” (though strength in certain names began to wear off in the fourth quarter).
Market and economic activity beyond equities was remarkable as well. Reassured by moderating inflation and relatively strong employment data, the Federal Reserve embarked on its first easing cycle in four years, cutting its headline Fed Funds Rate from a target range of 5.25% - 5.50% to 4.25% - 4.50% currently. By and large, economists and analysts see inflation—as measured by the Consumer Price Index (CPI-U)—closing out 2024 around 2.9% higher than the prior year, slightly above the long-term average of 2.6% but significantly lower than 2021-2023’s year-over-year increases. Using this figure as a “best estimate” in our CPI model, we forecast the pace of inflation in 2025 will remain modest compared to recent history (Figure 2).
That’s good news for the overall health of the economy. Though not necessarily a direct determinate of Gross Domestic Product (GDP), inflation has a meaningful impact on consumer and corporate spending and, as evidenced by the Fed’s policy decision-making framework,2 can further influence short-term interest rates—in turn affecting the cost of borrowing. Such factors also play into investor confidence, which often guides equity market performance. After all, though investors cannot exactly “trade” GDP, they can buy and sell the shares and debt instruments of the corporations and other entities that ultimately influence it. With real money on the line, it is these investors—often more so than economists—that are incentivized to “get it right.” And while we have previously stated and continue to firmly believe the stock market is not the economy, historical analysis has shown a correlation between market prices, borrowing costs, and economic performance. Combined, these prevailing factors appear to indicate that the economy—as proxied by GDP—should remain relatively robust in 2025 (Figure 3).
Of course, estimates are just that…estimates. While some may claim accuracy in their forecasts down to the nth decimal, market-based measures are more finicky. However, our analysis shows that the majority of possible GDP outcomes in 2025 could be above average.3 Altogether, markets appear to be pricing in some additional economic upside for the year ahead, though risks remain. With patience and a little bit of luck, 2024’s relatively steady momentum might just carry into 2025.
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1 Performance on a total return basis.
2 The “dual mandate” of the Federal Reserve largely guides its monetary policy decisions. In theory, the Fed’s two primary considerations are promoting maximum employment (or inversely, minimizing unemployment) while preserving price stability (keeping a cap on inflation).
3 Across our historical look-back period (1965 to today), GDP growth has averaged 2.9% per year. Since 2000, this average has narrowed to 2.2% per year.