COMMENTARY: Market conditions in 2025

Whether you are a bull or bear in 2025, one thing is for certain: the markets will remain mercurial at best. Investors are focused on what President Trump is tweeting daily on Truth Social, but they should be paying close attention to what Federal Reserve Board Chairman Jerome Powell is signaling about interest rates.

And those indications seem to change with every new inflation or employment number month to month. For example, a recent change in non-farm payroll was much higher than expected, and the unemployment rate ticked down one-tenth of a percentage point to 4.1%.

The markets sold off because this was interpreted as a sign that the Federal Reserve would not cut interest rates as much in 2025. The following week, the two main inflation numbers that the market closely watches — the producer price index and the consumer price index — were both weaker or less inflationary than expected, and the markets rallied.

These significant changes make it harder to be a long-term investor because volatility makes investors uncomfortable. However, “volatility is the price you pay to build wealth” as our Chief Investment Officer, Michael Dow, likes to say.

Factors to watch in 2025 are: tariffs, tax cut extensions, inflation and what the Federal Reserve does with interest rates. Any or all could have a major impact on the direction of both the stock and bond markets. 2025 could prove a more difficult year for the markets than 2023 and 2024’s double-digit returns.

Tariffs

There has been much speculation about President Trump’s potential use of tariffs, and now that he is president again, we will see if any come to fruition. He used the threat of tariffs on China, Mexico and Canada while running for president and it’s put on hold for now.

If these tariffs are imposed, any imports from these countries would be more expensive for the American consumer, likely causing inflation to rise, all else equal. If inflation goes up, the Federal Reserve would be hard-pressed to cut interest rates in 2025.

Extension of 2017 Tax Cuts

Most people don’t remember these tax cuts five years ago, but they were a significant boost to households and corporations. Although it would provide some relief to our budget situation, many constituents will be negatively affected if the 2017 tax cuts are allowed to expire at the end of 2025 – as they will unless extended by Congress and signed into law by President Trump. Individual tax rates and corporate tax rates were lowered to 37% at the highest bracket and 21% at the corporate level. The standard deduction was increased to $15,000 for individuals and $30,000 for married couples today.

For 2025, the estate tax exemption has increased to $13.99 million per individual and $27.98 million per couple.

One of Trump’s signature campaign promises was to extend or make these tax cuts permanent to help stimulate the economy. Today, the Republicans have a slim majority in both the Senate and the House, and odds are they would need to use the budget reconciliation process to accomplish this goal. Some Republican members of Congress would like to see any increases in the federal deficit offset with spending cuts. And since the largest government spending programs are Defense, Social Security and Medicare, this is not easy to do.

Interest on the U.S. debt is higher than Defense spending at almost a trillion dollars a year, so higher interest rates only add to this number and make cuts to government spending even harder.

Inflation

As the most recent inflation reports showed, inflation is well below the 9.1% level in the summer of 2022, to just under 3%, but not yet down to 2% which is the Federal Reserve’s stated target. If inflation doesn’t improve this year, there is a good chance the Federal Reserve will not lower the Fed Funds interest rate of 4.5% in 2025. And if tariffs prove to be inflationary, Powell and the Federal Reserve will be forced to raise interest rates. The markets are not expecting this scenario and we believe it would be a huge negative for investor sentiment. As we saw in 2022, higher interest rates can cause negative stock and bond market returns.

Federal Reserve

Powell’s term as chair of the Federal Reserve ends in May 2026, and President Trump has made it crystal clear Powell will not be reappointed to another term. So, he and Trump will need to figure out how to co-exist until then. Likely, Trump will push Powell to cut interest rates further and Powell will continue to maintain the Fed’s independence and remain vigilant about fighting inflation. The Fed will closely monitor the economy and inflation with monthly economic data. The bond market could react quite negatively to any interference by President Trump, so he should probably be careful what he tweets about Powell and Fed interest rate policy.

The last time the stock market had 20% returns back-to-back was in 1997 and 1998. This was during the internet era when Alan Greenspan was the Federal Reserve Board chair. To get a third 20% return in 2025 would be highly unusual primarily because the market is expensive, and the forward price earnings ratio is 22, much higher than the average of 18.

The other headwind the market is facing is interest rates. They were expected to be cut another 1% during 2025, but now there may only be one cut this year, or possibly zero cuts. Lower interest rates make the market look cheaper since bonds and stocks compete against each other for investor dollars.

About the only thing investors can count on in 2025 is that it won’t be uneventful.

Fred Taylor is a partner, managing director at Beacon Pointe Advisors LLC. The information contained in this article is for general informational purposes only.

Opinions referenced are as of the publication date and may be modified due to changes in the market or economic conditions and may not necessarily come to pass. Forward-looking statements cannot be guaranteed. Past performance is not a guarantee of future results. Beacon Pointe has exercised all reasonable professional care in preparing this information. The information has been obtained from sources we believe to be reliable; however, Beacon Pointe has not independently verified or attested to the accuracy or authenticity of the information. The discussions, outlook, and viewpoints featured are not intended to be investment advice and do not consider specific investment objectives or risk tolerance you may have. All investments involve risks, including the loss of principal. Consult your financial professional for guidance specific to your circumstances.