Looking Ahead: Q1 2025 - Macro and Asset Outlook

As 2024 comes to an end, we close the curtain on what has been a tremendous year in macro. Heightened volatility and macro instabilities, both created by paradigm shifts, gave rise to multiple opportunities throughout the year which have all been documented here.

While I was pretty upbeat about growth coming into 2024, I cannot say the same for 2025 and would even venture out to say that risk will more likely be tilted to the downside. As I see it, the dovish bet made by the Fed will backfire by steepening the curve (already happening), which is probably going to weigh on housing all the while fiscal spending slows down. Moreover, I am not too confident to say that Trump's fiscal plan could reverse the situation, for now at least.

All things considered, a recession is still not in the cards, and I think the economy will do just fine, but those 2 forces will likely shape the path ahead for growth, inflation, and asset prices subsequently.

Growth:

Trump’s plan revolves around 2 central points:

• Extending the TCJA and cutting taxes

• Imposing tariffs and cutting immigration

Markets seem to view Trump's fiscal policy as stimulative, but I do not entirely share that opinion. Extending the TCJA is more about preserving the status quo for tax policy rather than providing extra fiscal support. Both outlays and revenues won’t change if the TCJA is extended; this means no stimulus at the margin. Moreover, the proposed corporate tax cuts (21% to 20%) are much smaller compared to 2016 (35% to 21%). All in all, investors' optimism seems a bit stretched to me; Trump doesn’t have the same margin he had in 2016 or early Covid. Tariffs and immigration could be inflationary at the margin (more so immigration), but the context matters here, so we’ll put that aside for now.

According to the CBO, expenditures will remain high but should nonetheless stabilize a bit lower in 2025 compared to the 2023-24 levels (YoY%). I’ll make sure to update the fiscal outlook once the CBO takes into account Trump’s proposed policies, but like I said, I think the effects will be minimal (I could be wrong though).

Housing:

Housing showed some sign of life back in September following the fall in long-term rates; mortgage applications, permits, and starts all ticked up. This optimism was short-lived though as yields quickly went back up and the curve steepened in a short period of time. Since then, all those housing indicators either went down or stayed mostly flat.

More importantly, housing volume continues to fall, which is the most important determinant of residential construction employment. As completed units continue to outpace housing starts, the number of units under construction keeps falling and is approaching the threshold where we will start to see some potential job losses.

Completed homes as a % of new homes (completed, under construction, and not started) keeps rising and tells the same story essentially. Big thanks to Eric from EPB Research for the chart.

Simply put, in order to balance this dynamic and avoid job losses down the line, long-term rates need to adjust lower. As things currently stand, we could see some weakness in the sector around Q2/Q3.

Short-term growth cycle:

When I incorporate all these dynamics into my model, the picture is the same. Growth will likely slow down somewhere in mid-2025 on the back of reduced fiscal support and housing headwinds. This is not a recession call, only a moderation in growth. The implications are much more important for assets though.

Inflation & Interest Rates:

The story of these past few months has been the «unexpected» stickiness of inflation, which has seemingly caught the market and the Fed by surprise. Fed officials committed to a dovish stance back in Q3 only for core inflation to bottom shortly after. Now, they are caught in a sort of limbo between retaining their credibility and effectively managing inflation.

On our side, this was correctly anticipated back in September. In our piece, eying a potential tactical short on bonds, we suggested that core inflation would probably bottom at 3% and that shorting bonds presented a decent risk/reward opportunity to profit from an eventual repricing of the curve.

Ironically, adopting a dovish stance was the best move from Powell if he was playing 4D chess with the market. If his goal was to truly bring down inflation, then having the curve steepen would slow down the economy more than keeping it inverted as it was previously the case. This is because the real economy’s true lending rate is at the very back of the curve as opposed to the front. Only, I don't think that fed officials play at this level.

Looking ahead, core inflation will have a hard time falling further. I won’t go into the dynamics of inflation again, as it has been explained in detail in the previous bond piece, but by using conservative assumptions for each model input, only a sudden slowdown in growth would command lower levels of core inflation, which I honestly don’t see happening over the short-term.

Both the Fed and markets see 2 cuts for 2025, which is drastically different from the 150 bps of cuts we saw at the end of Q3.

This sudden rise in long-term yields, coupled with the potential growth headwinds discussed above, could sow the seed for potential trading opportunities somewhere in 2025. Housing volume will most likely continue to fall now that rates are even higher, and surely this situation won’t be sustainable for too long. I’ll keep a keen eye on this.

Assets:

Stocks continue to make new highs on the back of both earnings and valuations expansion.

Valuations are high, but I don’t think it’s as bad as what we saw in early covid. As tech stocks, which naturally have higher P/Es, represent a larger and larger share of broad indices, valuations will need to adjust higher from a simple arithmetic perspective. This paradigm shift seems to pass as a simple bubble for most market participants, but the truth is that small and mid-caps are still quite undervalued, something that wouldn’t happen during a bubble. Moreover, the rise in profit margins is another argument against the irrational exuberance case.

Going forward, earnings will need to do the heavy lifting as valuations have limited upside from current levels. I’d be surprised if earnings grew at the same pace they did in 2024 given what likely awaits us, but nonetheless I remain bullish on equities.

I hold a position in Nasdaq futures but haven’t added since early September.

Bonds & Gold:

Given my current conviction on growth and inflation, being long Gold is probably the trade I have the most faith in. Already helped by its bullish secular trend, I believe that short-term real rates’ upside potential will be quite limited with an already weak housing market. Both scenarios cannot coexist for too long, and I think real rates will adjust lower as housing weakness persists. Still, I am ready to change my mind if I see any shift in the thesis.

I added to my already existing position on November 18, as explained in my last gold piece.

Regarding bonds, I should've definitely held longer to my short when I look at current yield levels. This quite annoyed me to be honest, but I'll make sure to make an in-depth review for future similar opportunities.

Similar to my gold thesis, buying bonds could present a decent opportunity if the growth outlook explained above materializes. For now though, I prefer gold. Actually, throughout the year, I played every top in yields by buying gold and played every bottom by either going short bonds (successfully) or long USD (unsuccessfully). I usually prefer to add to an asset with an already existing secular trend; this provides better risk/reward in my opinion.

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Later.