2025 Investment Outlook
Clients of the Firm,
Bob Dylan said, “There is nothing so stable as change”. As the year winds down with a small market correction, we find ourselves with stock market valuations near the high end of their historical range. This is in large part due to the heavy concentration of technology companies in the market cap weighted S&P 500 index. Based upon the Factset earnings estimate of $277 for 2025 S&P 500 earnings, the index is trading at roughly 21.29 times forward earnings. The VIX stands at a slightly elevated 18.75 and the ten-year Treasury is at 4.55%.
There continues to be a compelling bull case for equities in the coming years. The compounding impact of lower corporate tax rates, AI efficiency and share buybacks are likely to add meaningfully to corporate EPS. In addition to these factors, we continue to experience a growth economy with recent and projected U.S. GDP growth north of 2%. Further growth would also contribute to higher corporate profits.
While near term valuations may be somewhat stretched, longer term forward compounding momentum has the tailwinds mentioned above. If company earnings grow at a substantial rate, stock price levels could be justified in going higher. Indeed, it is possible total average compounded rate of earnings growth for the next four years could be high single to low double digits per year with a growth economy scenario. While some of this potential outcome is currently priced into equity markets, we could see further price appreciation ahead, albeit at a slower pace.
Our expectation for bonds in 2025 is that they will be range bound for US Treasuries and corporates issues. Our base assumption is that we will see a 3.5-4% Fed funds rate in the coming year. We also expect a term premium to be priced into longer-term Treasuries with rates ranging between 4.25-5% for maturities of 5-20 years. In addition, we anticipate a risk premium on higher quality corporates bonds and yields to vary between 5.25-6%.
Our base case for 2025 is for Fed funds policy to continue on a path to 4%. We would then expect a pause in rate cuts. In addition, we expect the Fed to be very data dependent in 2025 and that they will adjust policy accommodation or tightening as fiscal and tax policy unfold. The set of considerations will incrementally include income and corporate tax policy and increased tariffs. These items will be in addition to the usual Fed mandate of trying to aid maximum employment in the context of price stability.
Given these rate expectations, a balanced portfolio approach still makes sense for many clients. Further, we anticipate more volatility in 2025 due to policy uncertainty from the new administration and the unpredictable manner in which policy decisions are likely to be communicated. This volatility expectation lends itself to continued hedging of risk and implementing allocations that consider volatility as part of overall portfolio construction.
We think tariffs will evolve to be company specific negatives or positives. Their implementation will likely create increased volatility and have an impact on the flow of goods and services globally. We also anticipate lower corporate tax rates for domestic producers will be put on the table as a GOP controlled government takes office. Our expectation is that personal taxes will likely remain at or near current levels with the chance of SALT provisions coming back or at least higher maximum deduction levels.
From an energy price perspective, we anticipate volatility to be infused from a maximum pressure campaign on Iran which could include restrictions on oil sales. This impact will likely be somewhat damped by reduced restrictions on domestic oil production in the U.S. Other support for energy prices will come from the massive increase in power consumption from the developed countries as AI and other advanced technology rollouts will require increased demand. Alternative energy to fossil fuels will play a big part in delivering the energy needed including small scale nuclear plants and large scale solar, particularly in China. We believe the demand cycle will be long lived and will provide a floor under energy prices and a tailwind for energy production and distribution businesses in the years ahead.
In quantum physics, we are taught that merely observing a state can cause it to change. We live in a time of uncertainty and change. This has always been true in the American experience. As Bob Dylan said, don’t expect that to change. As such, it remains as important as ever to overlay a rational risk-managed framework on top of our investment thinking. This allows us to take advantage of the change that is around us in both the price and the nature of companies in which we invest. Applying this framework is essential in investing success as we navigate the year ahead.
As always, we thank you for your business and the opportunity to service you this year and the year ahead. We wish you a happy and healthy new year.
Sincerely,
Peter C. Wernau
President, CEO
Wernau Asset Management
http://www.wernauassetmanagement.com/
Office: 617.871.0029
Important Legal Disclosure
This letter contains general information that is not suitable for everyone. The information contained herein should not be construed as personalized investment advice. Past performance is no guarantee of future results. There is no guarantee that the views and opinions expressed in this newsletter will come to pass. Investing in the stock market involves gains and losses and may not be suitable for all investors. Information presented herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security. Wernau Asset Management, Inc. ("Wernau Asset Management) is a registered investment adviser with its principal place of business in the Commonwealth of Massachusetts. Wernau Asset Management and its representatives are in compliance with the current registration requirements imposed upon registered investment advisers by those states in which Wernau Asset Management maintains clients. Wernau Asset Management may only transact business in those states in which it is registered or qualifies for an exemption or exclusion from registration requirements. This letter is limited to the dissemination of general information pertaining to its investment advisory services. Any subsequent, direct communication by Wernau Asset Management with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides. For information pertaining to the registration status of Wernau Asset Management, please contact Wernau Asset Management or refer to the Investment Adviser Public Disclosure web site (www.adviserinfo.sec.gov). For additional information about Wernau Asset Management, including fees and services, send for our disclosure statement as set forth on Form ADV from Wernau Asset Management using the contact information herein. Please read the disclosure statement carefully before you invest or send money.