Strong Earnings and Growth Signal a Bright 2025 Outlook

In this video Bernhard shares how. despite high valuations, productivity gains and cooling inflation set the stage for continued expansion.

Hi there. This is Bernhard Koepp wishing you a happy new year.

Well, it’s been a happy new year if you’ve been long equities. We finished the year 25% plus for the S&P 500. That’s on top of a big year in the previous year, 2023. If you’ve been long equities for the past two years, you’re up about 50%; that’s not a bad return.

Economists and strategists are looking at their 2025 forecasts. There have been a lot of events in the economy, in politics, geopolitically abroad and domestically where people need to look at their forecast. Let’s start with inflation.

Inflation was the topic of the last couple of years. The Fed is still in an easing cycle, but it’s unclear whether the tail-end of the inflation worry that we had in the last couple of years is now really behind us.

The big components of inflation are wages and shelter. Let’s look at wages. If you look at the three or four indicators of wage inflation, they’re all around 4%. Four percent sounds high, but if you factor in productivity growth, which is about 2%, then you take 4% inflation for wages minus 2% for productivity, you get to around 2%. That’s not bad. And if you look at the history of productivity growth as well, we’ve come a long way. If you look at the tail-end of the great financial crisis in the ‘09 period, and we came out of that in 2010/11, productivity growth was zero. In 2015 we started finally getting a lift in productivity at about a half a percent. Being at 2%, we’ve basically quadrupled productivity growth. That is a good sign that the economy and the technology innovation that we’ve gone through, whether it’s today’s generative AI or the accelerated adoption of cloud computing that we saw in the pandemic, all of these things are actually adding to the economy, which is really positive.

Rent inflation is still at 4.8%, that’s come down a lot from the previous high. The reading for November was 4.8%. We don’t have December yet, but the trajectory for rents is really coming down. We should see relief from rents as well, not just from the wage side, but also from rents.
There are a couple of things in CPI that are distorting the numbers, and we’ve talked about this in the past. Auto insurance is still high, and if you’ve renewed your auto insurance or home insurance, or any kind of insurance, it’s still very high. That is due to a number of factors from heightened flood risk floods and the environment. That’s one distorting factor in CPI.

If we look at oil and gas, we also see relief there. If you look at gasoline prices historically in April of ’24, they peaked for regular gas at around $3.60. If you’ve filled up your tank recently, regular gas is now $2.75 or $2.80. That’s quite a drop. Again, deflationary pressures are creating relief on the gasoline side.

Turning to GDP, 3% is not a bad level of growth out of 2024 going into 2025. That translates into very decent strong earnings per share of growth, and of course as equity investors that is what we care about the most. There is an acceleration of earnings per share going into 2025, which is something that’s missed by many strategists who are bearish going into 2025. We’re quite optimistic given how our companies, especially on the technology side, are performing. We’re seeing accelerated growth into 2025, which is quite good.

The strong secular growth drivers that we’ve been talking about in the past are still very much in place. Of course on the technology front, we’re talking about the adoption of generative AI. We’re only at the very beginning of this, and it’s really the infrastructure build-out that you need to roll out this great software that is driving productivity. We are in the phase where it’s still the semiconductors, it’s fiber optics, it’s all sorts of things that are in power. There is not enough power being generated to actually power all of the data centers.

The other big secular growth trend that we’re watching is reshoring.Reshoring is probably one of the biggest trends happening all over the world where we’ve learned the hard way through the pandemic that some very critical supply chains need to be more onshore, but it’s also technology that’s driving that trend.

Valuations are also not cheap, and the pessimists on the markets are saying, “Well, at 24 times or 25 times earnings for the S&P, and that’s on ’24 earnings, that’s very high.” I can tell you as a portfolio manager for the past 30 years, I’ve seen very high valuations before. That doesn’t mean the bull market comes to an end, it’s just a question of how fast the underlying earnings are growing and how sustainable they are. If we look into 2025, which has started today, the multiple comes down to 21.6 times. We have 12% earnings growth going into the new year. And actually, the earnings estimates are even higher for 2026. That’s where the risk is and that’s where forecasters can get it wrong. If you look at it today, looking into the future, this is not a decelerating growth story. It’s actually an improving growth story, which is something we like to see.

Turning to the politics, we have a new administration coming in, so there’s a lot of risk associated with the policy side because we don’t really know what’s going to happen. The market is telling us that the market feels deregulation is going to trump the risks of tariffs. We’ve heard a lot about tariffs in the last couple of years in the campaign. It’s not just the new Trump administration. The Biden administration also has been using tariffs. Tariffs are typically inflationary and are typically a counter to GDP growth. However, the market today is saying that the forces of unleashing economic growth through the deregulation side is going to be much stronger than the sort of blunt policy tool that the Trump administration has been talking about regarding tariffs. We’ll see if that’s correct, but so far so good.

Geopolitically, 2024 has been a terrible year when it comes to hot wars and conflict around the world. If you want to take a more positive view on that, peace may trump wars in the coming year so we’ll see what happens in the Ukraine, and in the Middle East. Of course wars are inflationary; if you have more peace and less war economy type growth, that is also deflationary. We’ll hope for the best there.

In short, the European economies can certainly gain a lot from peace in the Ukraine. China has been talking about fiscal stimulus a few times now, and they are very concerned about decelerating growth there. On the international front, we may also get some relief there.
To sum it up: it’s been a terrific couple of years to be long equities. The interest rates are now to the point where you can nibble on bonds as well. Shorter term, we’re careful about having duration there because there still may be some inflationary pressures down the road given the strong growth that we’re seeing. But again, it’s a pretty good environment to be invested. That’s something we’ve said to our clients over the years. It is more important to be invested than to try to time the market because you can be so wrong, and the last two years are a good example of that.

Wishing you a healthy and happy new year, and again, you can contact us if you have any questions. All the best for the new year.