2025 Stock Market Outlook
My outlook for 2025 is as follows: Strong earnings growth in the Russell 2000 (small-cap index) and S&P 500, coupled with GDP growth of 2% to 3%, advancements in business productivity driven by new technologies and AI, and the potential for tax cuts and deregulation, could significantly boost earnings potential in small-cap stocks and the broader S&P 500 (beyond the "Magnificent Seven”). These factors may lead to a broadening of market performance, shifting the focus away from a few dominant companies. If these catalysts materialize, the S&P 500 could surpass 6,500, while the Russell 2000 might climb to 2,700. This translates to potential gains of at least 10% for the S&P 500 and 20% for the Russell 2000, relative to their values at the start of the year.
Reasons Supporting My Bullish Outlook
Strong Forecasted Earnings: Corporate earnings are crucial to stock market performance. 2025 S&P 500 earnings are projected to surge 14.8%, well above the 10-year average of 8%. This growth is expected to extend beyond the "Magnificent 7," suggesting broader market strength. The Russell 2000 is set to outperform, with earnings growth estimates exceeding 40%. If these projections hold, it could provide a strong tailwind for stocks, especially small caps, in the year ahead.
Moderate to Strong GDP Growth Bodes Well for Markets: Top banks forecast 2025 U.S. GDP growth at 2.5%, above the 2.1% consensus. GDP growth is crucial for the stock market as it drives consumer spending, business profits, and corporate earnings. Historically, GDP growth between 2.1% and 3% has led to an average stock market return of nearly 11%, while growth between 1.1% and 2% often resulted in negative returns (as shown below).
The Business Productivity Boom: A Game Changer for Economic Growth: Business productivity is key to sustained U.S. economic growth. It allows the economy to expand faster without triggering inflation. Advances in AI and technology are driving a productivity resurgence reminiscent of the 1990s internet boom. For five straight quarters, U.S. productivity growth has exceeded 2%, well above the pre-pandemic average of 1.6%. These innovations help businesses address labor shortages, boost profits, and raise wages, all while keeping product prices stable. This tech-driven momentum could propel economic growth beyond historical norms, further strengthening the economy.
Tax Cuts and Deregulation Could Boost Stocks: Tax cuts and deregulation can drive corporate earnings and boost stocks. Trump has proposed lowering the corporate tax rate from 21% to 15%, allowing companies to retain more profits for reinvestment or shareholder rewards. Deregulation reduces costs, improving profit margins and boosting overall earnings. The Russell 2000 could see significant gains, as small-cap stocks benefit most from these policies. Additionally, deregulation encourages mergers and acquisitions, often enhancing small-cap performance.
Small-Cap Stocks Could Benefit from Tariffs: Tariffs are taxes on imports that protect local businesses by boosting the competitiveness of domestic goods. Small-cap stocks, which generate over 80% of their revenue in the U.S., are less impacted by trade wars and supply chain disruptions under tariff policies like those imposed by President Trump.
Risks to Outlook: Market Upside Despite 5-10% Correction Risks
The 10-Year Treasury Yield Surging Above 5%: The Fed's hawkish stance, strong economic data, persistent inflation fears, and higher rates, combined with the looming debt ceiling debate, have pushed the 10-year yield significantly higher. This widening gap between the 10-year yield and the Fed Funds Rate could trigger a stock market correction. Rising yields increase borrowing costs for businesses and consumers, potentially slowing economic growth. Additionally, higher yields offer more attractive returns than stocks, possibly diverting investment away from equities.
Strategists are closely watching the 5% threshold on the 10-year yield, as past surges in April 2024 and Fall 2023 led to significant stock pullbacks. The relationship between bond yields and equities has shifted, with rising yields now driving stock declines.
Potential Slowing GDP Growth: Impact on Markets in 2025: GDP growth in 2025 could slow to 1% to 2%, a level typically negative for markets. A slowdown to around 1.5% in the second half of 2025 could result from lower real wages, weaker consumer spending, reduced business investment, and declining net exports.
Rising Inflation and Rate Uncertainty in 2025: Inflation could rise in 2025 due to President-elect Trump’s proposed policies, such as tariffs. For instance, a 10% duty on global imports and 60% on Chinese goods could raise costs, disrupt trade, and prompt retaliation against U.S. exports. These tariffs are quite extreme, much like the Smoot-Hawley Tariff Act of 1930 that worsened the effects of the Great Depression. Persistent inflation adds to uncertainty, with many investors predicting that the Federal Reserve will refrain from cutting rates in 2025. To curb inflation, the Fed may maintain its cautious stance, potentially leaving interest rates unchanged.
Is the S&P 500 Really Overvalued? The S&P 500 might seem expensive at 22x earnings, but this is driven by 7 high-growth stocks trading at 27x. The median S&P stock, however, trades at 16x earnings, in line with the 50-year average, suggesting the index isn't overvalued overall.
Conclusion
As we look ahead to 2025, several factors could shape the market's trajectory. Strong earnings growth, moderate to strong GDP expansion, advancements in AI and productivity, and potential policy tailwinds from tax cuts and deregulation may drive significant gains. While I believe the market will end the year on a high note, risks such as higher Treasury yields, slowing GDP, rising inflation driven by tariffs, and persistent rate uncertainty could trigger a 5–10% correction during the year.