Fogel Capital Management’s Q1 2025 Outlook
By Nick Skillman, CFA®
2024 in Review
The past year can largely be characterized as a risk-on environment driven by positive economic growth and falling inflation. Opportunities to fade extremes were presented, as market participants overreacted to individual economic data points and priced unrealistic outcomes across assets. In our 2024 outlook, we discussed the likelihood of the market incorrectly pricing both the speed and timing around interest rate cuts implemented by the Federal Reserve. If we look back, the market was projecting six rate cuts beginning in March 2024, but we argued that such policy action historically aligned with periods of significant deterioration in economic growth, which was clearly absent in the data at the time. Our assessment proved correct, and as growth exceeded expectations in the first half of the year, the probability of recession was priced out of the market. As a result, the Fed’s initial rate cut was postponed to September and risk assets inflected higher.
As markets adjusted to the “higher for longer” narrative, the subsequent rise in interest rates in turn pressured growth metrics. In August, the unemployment rate jumped to 4.3%, prompting the Fed to pivot with a 50-basis-point cut and explicitly shift its focus from taming inflation to supporting the labor market. This was a clear example of markets pricing an extreme. Risk assets had begun pricing in an economic downturn; meanwhile, growth was considerably positive, and unemployment, although having increased to over 4%, remained at historically low levels. When fears around the labor market ultimately subsided, the combination of resilient growth and a newly accommodative Fed increased short-term inflation expectations, leading to a notable sell-off in bonds into year-end.
Macro Outlook for Q1 2025
We revisit the revolving tensions of 2024 because, as the new year approaches, the market presents similar dynamics. At the December FOMC meeting, the Fed surprised markets by revising its outlook for future interest rate cuts, now forecasting only 50 basis points of easing in 2025 down from 100 basis points previously. The justification for this shift in forward guidance was cited as an increase in inflation expectations and strength in the labor market.
Our issue with this reasoning is that although inflation has increased only slightly in recent months, the concurrent rise in rates has been disproportionately larger. The 10-Year Treasury yield has risen to 2023 levels, when real GDP was well above the historical average. Today, growth and inflation have returned to more normalized levels, meaning the economy’s sensitivity to the level of interest rates will be higher moving forward. We expect the recent increase in rates will begin impacting growth, leading to economic data weakening over Q1 2025. To be clear, we do not anticipate an outright contraction but, rather, a marginal slowdown, with realized growth coming in below estimates.
The spread between the Fed Funds Rate and the 2-Year Treasury yield currently sits at just 20 basis points, indicating the market has effectively priced out any easing in monetary policy over the next two years. This, combined with our expectations for growth, leads us to believe the rates market is mispriced and that the Fed will cut interest rates more aggressively than currently projected. The extent at which rates decrease over the next few months, and its resulting impact on risk assets, will depend on the stability of growth and employment at this stage in the cycle, amidst elevated rates. If the level of growth remains steady and short-term inflation risks dissipate, risk assets should remain supported as rates normalize marginally lower against a stable economic backdrop. Conversely, if growth proves more sensitive to current rate levels, something that would indicate a clear character change, we would expect a sharper decline in yields, coupled with downward pressure on risk assets as economic weakness affects earnings expectations and creditworthiness.
Despite the downside risks that exist for growth, the near-term probability of recession remains low. Corporate bankruptcies, consumer credit delinquencies, and mortgage defaults all remain at comfortable levels. Moreover, the Fed has demonstrated its willingness to intervene to support the labor market and broader economy. With ample room for rate cuts, the risk of a significant contraction appears minimal. Instead, we anticipate continued oscillations between overly hawkish and dovish action by both the Fed and market participants. These fluctuations will likely occur against a backdrop of relative economic stability, with growth and inflation remaining within manageable ranges.
Investment Approach Moving Forward
Given these conditions, it is unlikely that we see a substantial rally in risk assets, similar to that of 2024. For equities specifically, we expect below-average returns on an index level with larger rotations taking place under the surface. Additionally, significant policy changes are expected from the incoming administration. Periods of volatility and uncertainty are likely to occur as markets digest structural shifts.
While declining interest rates would typically be supportive of equity multiples, recent performance has largely been driven by valuation expansion, which now appears extended. This heightens stock price sensitivity to shifts in economic conditions, thereby capping the upside for broad equity indices in the intermediate term. A more compelling long-term buying opportunity will likely require a catalyst to reset valuation multiples or sustainably boost earnings growth.
In the short-to-intermediate term, it’s worth noting the S&P 500 has been supported by a narrow subset of its largest components, while a majority of stocks have seen weakness into year-end. Cyclicals and other rate-sensitive sectors are positioned to reprice higher once interest rates and the dollar stabilize, as long as growth does not fall into contraction. These sectors could outperform in the coming months as they front-run the potential for more aggressive rate cuts.
Regarding corporate bonds, credit spreads remain historically tight. Non-investment grade debt offers less than a 3% premium over U.S. Treasuries. Given our growth outlook, risks are skewed toward credit spreads widening. This increase in credit risk should lead to larger demand for government bonds, driving interest rates lower. Similar to equities, the returns of corporate bonds attributable to a decline in interest rates will be partially offset by the increase in credit risk. While individual securities continue to present investment opportunities, a more favorable risk-reward profile for the corporate bond market will likely require a widening of credit spreads that outpaces the relative change in economic conditions.
Partner With a Professional
Navigating the complexities of today’s financial markets requires research, experience, and a clear strategy tailored to your goals. At Fogel Capital Management, we take pride in delivering personalized strategies from our office in Stuart, FL, or New York, NY, that align with each client’s unique financial needs.
Whether you’re an individual investor or an institution, our team works closely with you to construct an investment strategy that supports your objectives. From portfolio management to navigating economic shifts, we’re here to help you make confident financial decisions—no matter how the markets evolve.
To learn more about how we can support your investment journey, call us at (772) 223-9686 or email mcfogel@fogelcapital.com.
About Nick Skillman
Vice President, Portfolio Management
Nick joined Fogel Capital Management in the spring of 2019, after graduating from the University of Florida with his Bachelor’s Degree in Finance. He serves a variety of roles on the investment team, of which include assisting Fogel Capital’s Head of Trading in the management of client accounts, conducting extensive capital market research, and communicating personalized investment analysis to clients with regards to investment strategy, portfolio construction, individual security selection, and risk exposure. He holds the Series 65 Uniform Investment Advisor License and strives to provide personalized investment advice for each individual client. He has also furthered his knowledge and capabilities in portfolio management and asset valuation through his completion of the Chartered Financial Analyst® Program, where he is an active charter-holder.
Disclosure: Fogel Capital Management, Inc. strives to maintain the accuracy of all data presented in this material. The information provided is intended to disclose data that may not be otherwise known and should not be construed as personalized investment advice. Past performance is not indicative of future results. The data presented in this material is copyrighted by Bloomberg L.P. and is sourced through Bloomberg L.P.’s services. This material is confidential and should not be reproduced without the express consent of Fogel Capital Management, Inc.