Life rarely unfolds as planned. An unforeseen car repair can derail your monthly budget, while a persistent illness might delay the completion of a critical project.
This unpredictability is particularly evident in the realm of central planning. A five-year plan may set forth specific goals and a clear pathway to achieve them, but real-world events often steer things off course.
On September 18, the Federal Reserve initiated a cycle of rate cuts when the yield on the 10-Year Treasury note stood at approximately 3.70 percent. Despite a full percentage point reduction in Fed rates, the yield on the 10-Year Treasury has now surged to 4.60 percent, indicating a divergence from the Fed’s rate cuts.
A potential explanation for this trend lies in the Fed’s premature declaration that its battle against consumer price inflation was won. The central bank anticipated that the slowing rate of inflation would persist and that prices would soon fall in line with its arbitrary 2 percent target.
The core personal-consumption-expenditure (PCE) index, which excludes food and energy prices, was recently reported to have risen by 2.8 percent over the previous year. Once again, the Fed has misjudged inflation and must reevaluate its strategy.
Currently, the FOMC’s dot plot indicates two anticipated rate cuts in 2025, a sharp revision down from the four cuts projected in the last meeting. This adjustment suggests that FOMC members, similar to 10-Year Treasury note investors, are waking up to the reality of persistent inflation.
But is there more at play?
Economic Headwinds in Europe
Ongoing high levels of consumer price inflation imply that interest rates should remain elevated, aligning with the movements seen in 10-Year Treasury yields. This reality is pushing the Fed to reassess its rate-cutting intentions.
However, what if FOMC members and Treasury investors are overlooking crucial factors? What if the looming recessions in Germany and France are poised to influence Treasury rates downward by 2025?
This perspective was recently shared by Louis Navellier of Navellier & Associates. Navellier suggests:
“The global interest-rate collapse is just beginning. The European Central Bank is likely to cut key interest rates four to five times in 2025, potentially bringing rates down to between 2% and 1.75%. Many Fed observers and the FOMC remain unaware of the domino effects that may soon occur, particularly as Germany’s recession deepens. Similarly, France is also facing a recession.”
“A decline in interest rates worldwide will prompt capital to flow into U.S. Treasurys, decreasing those yields. Since the Fed tends not to counter market rates, I confidently predict that the central bank will implement four rate cuts in 2025.”
If Navellier’s forecasts hold true, it could mean that interest rates might dip in 2025, even as inflation persists. Typically, lower interest rates stimulate borrowing and spending, which can also propel stock prices higher.
What does this imply?
Market Valuations at Risk
The primary U.S. stock market indexes are currently inflated. The notion that these bubbles could grow even larger in 2025 defies logic.
The S&P 500, for instance, is nearing its historical peak. In 2024 alone, the index hit over 50 record highs, with a year-to-date increase of 27 percent.
However, evaluating prices alone gives an incomplete picture. The essential question is: Does the S&P 500 possess the earnings to justify such lofty valuations?
The S&P 500’s current price-to-earnings ratio, when compared to historical data dating back to 1871, reflects a market fraught with risk. The Cyclically Adjusted Price Earnings (CAPE) ratio stands at 38.35.
This is a staggering 123 percent above the CAPE ratio’s long-term average and even surpasses the 32.56 CAPE ratio recorded in September 1929. The only moments of higher CAPE ratios occurred briefly during the dot-com bubble peak in December 1999 (44.19) and in October 2021 (38.58).
Following these peaks in CAPE ratios—September 1929, December 1999, and October 2021—the markets experienced significant downturns. The first two resulted in dramatic crashes, while the more recent sell-off contributed to the bear market of 2022.
In summary, considering the present CAPE ratio, the S&P 500 is priced at more than double its historical average, with both the NASDAQ and DJIA similarly inflated.
Moreover, the Buffett indicator, which measures total market capitalization against gross domestic product, indicates the stock market is significantly overvalued, landing at around 206 percent.
A fairly valued market would see this ratio between 108 and 132 percent, while any figure above 156 percent is deemed significantly overvalued.
Anticipating the Unexpected in 2025
The most dependable investment strategy in the stock market is to buy low and sell high. Conversely, purchasing high and selling low assuredly leads to losses. With current valuations, investing in major U.S. stock market indexes now equates to buying high.
It’s conceivable to buy high and sell even higher. While it may seem irrational, the stock market bubble could indeed inflate further. After all, bubbles, by definition, operate on irrationality.
Nonetheless, entering the market now with the hope of higher returns is not a wise investment strategy, unless one equates investing with gambling.
Successful long-term index fund investing necessitates acquiring assets when they are undervalued—ideally when the CAPE ratio is below 15 or the Buffett indicator is under 84 percent.
Given the current metrics from both the CAPE ratio and the Buffett indicator, the U.S. stock market is considerably overvalued. However, if Navellier’s analysis proves accurate, 2025 could see further inflation in the stock market due to capital fleeing from Europe to the U.S. and central bank monetary expansion.
This scenario suggests that as we enter the New Year, we may witness a whirlwind surge in major U.S. stock market indexes, which could be particularly dramatic. At the same time, the likelihood of a sharp market decline is also significant.
Therefore, our counsel for the coming year is to brace yourself for the unexpected in 2025. A frenetic surge. A dramatic crash. Both possibilities loom large. Anything could transpire in 2025.
Maintaining a small portfolio of dividend-paying stocks with stable earnings, alongside a greater allocation of cash, is a judicious approach. Additionally, possessing physical gold and silver bullion for protection against inflation and financial crises is crucial in light of current tensions in the financial system.
It’s shaping up to be an eventful year ahead.
Happy New Year!
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Sincerely,
MN Gordon
for Economic Prism
