Navigating market dynamics in 2025: Insights from Jurrien Timmer

Inflation and economic momentum

Timmer began by addressing the persistent issue of inflation, which in 2024 remained stubbornly high at around 2.83 - 3% level, exceeding the Federal Reserve's target. He expressed concerns that if the economy gains momentum, possibly fueled by tax cuts and deregulation, inflation could rise further, potentially leading to a "new normal" with inflation rates above the target, such as 3% or even 4%. This scenario could challenge the Fed's ability to maintain price stability.

The role of the Federal Reserve

He referenced the Taylor rule, an economic principle that helps determine the appropriate federal funds rate based on current inflation and unemployment levels. According to this analysis, the Fed had a green light to ease its rates, which they did by cutting rates three times in 2024. However, Timmer noted that market expectations from a year prior had anticipated a more aggressive approach with seven rate cuts instead of the three that were executed.

Looking ahead, Timmer raised concerns about the Fed's independence following the potential retirement of Jerome Powell, the current Chair. He speculated that a new appointment, influenced by the president and Congress, could lead to a more dovish stance if the political climate is favorable. While legislative efforts to undermine the Fed's independence are deemed unlikely, the potential for a leadership change could affect its approach to persistent fiscal deficits, which are expected to continue in the U.S. and other countries like Canada, the UK, and Europe.

Asset class performance

Timmer highlighted the performance of gold in 2024, noting its 30% increase, which outperformed the S&P's 25% rise. Additionally, Bitcoin experienced a significant gain of 120%. He mentioned a chart illustrating the correlations between different asset classes, indicating that many are positively correlated with the S&P, while only a few shows negative correlation, hinting at the complex dynamics within the financial markets.

The impact of Artificial Intelligence

He also discussed the performance of the utility sector within the context of market trends and the influence of artificial intelligence (AI). Utilities typically perform well during economic downturns due to their stability, but Timmer noted that certain utilities are increasingly connected to AI infrastructure, such as data centers, indicating a shift in how the sector is perceived and valued. This integration of AI is leading to a revaluation of traditional utility stocks.

Valuation trends and the CAPE model

Timmer referenced the CAPE (Cyclically Adjusted Price-to-Earnings) model, which uses a decade's worth of earnings to predict future returns. He emphasized that extreme valuation levels tend to revert to the mean over time. While the previous year's pricing was remarkable, there are ongoing considerations about how these valuations may adjust moving forward, particularly with emerging trends influenced by AI.

Market outlook

Looking ahead, Timmer suggested that while the next couple of years may see relatively good performance, overall returns in the next decade are expected to be below trend. He characterized the current market phase as the "seventh inning" of both a cyclical and secular bull market. He raised questions about the potential for shifts in the narrative of U.S. exceptionalism, comparing NVIDIA's current market position to past technology booms represented by Cisco in 1999 and RCA in 1929.

Earnings and market dynamics

Timmer contrasted the current state of earnings in the market with the dot-com bubble era. He noted that during the dot-com bubble, analysts altered the definition of earnings to justify high prices, leading to overvalued stocks. In contrast, the current earnings are described as solid, particularly for the "MAG7" stocks, which have significantly outperformed the broader market by a factor of 12 over the past decade. However, he expressed concern about the high price-to-earnings (P/E) ratios for the MAG7, which are at 38 times earnings, compared to 22 for the rest of the market.

Investment landscape and bond competition

Finally, Timmer discussed the current investment landscape, focusing on the competition between risk-free assets, particularly bonds, and the stock market. With bond yields around 5%, this presents a challenge for equities, especially given that the stock market is perceived as expensive. He noted that the era of negative real rates is over, making bonds and cash more competitive compared to stocks. While historically, the stock market has provided strong compounded returns, current valuation and sentiment levels may not support continued market growth, even with positive earnings momentum.

Conclusion