There will be a lot of “ink” spilled in the next two months. We could also say a lot of electrons will be zapping around describing various firms/authors points of view with regard to what will happen in 2025.
Quite simply, we believe corporate earnings will be the story for 2025.
In the simplest of terms, the US markets have outperformed the rest of the world’s markets due to strong earnings growth. RMH has always maintained that earnings growth is a major deterrence to any meaningful correction. In fact, a meaningful correction would be driven by an unforeseen geopolitical or economic event.
In looking at earnings growth, take China as an example. Their three largest tech companies: Tencent, Alibaba and Meituan, have average net profit margins of around 10%, with a return on equity of 9%. Compared to the three largest US tech companies: Apple, Nvidia and Microsoft, have average net profit margins of 42%, and returns on equity of around 89%. For comparison purposes. the Nasdaq 100 has gone up 78% since ChatGPT was introduced while the Hang Seng Tech Index is up only 16%.
Same for Europe, there is currently restrictive business regulation and very little in the way of entrepreneurship. Globally, where do you want to invest? We still believe strongly in the US economy.
The following is quoted from The Bull/Bear Report by SimpleVisor and describes what they believe drove this jump in small business confidence.
"Tax rates will not rise as the Tax Cuts And Jobs Act of 2017 will be made permanent.
There is a potential that corporate tax rates could be cut from 21% to 15%.
A reduction in regulatory overreach from the previous administration.
The reduction of illegal immigration and the institution of legal pathways for immigration.
A reversal of the abandonment of the 'rule of law.'
A shift in policies that will support U.S.-based businesses and encourage domestic production.
Expedited permitting for U.S.-based business development investments.
While these policies are designed to support U.S.-based businesses, they present some risks that should not be overlooked. For example, while corporate tax cuts and deregulation may enhance profitability and investment, trade policies and immigration restrictions could introduce challenges such as increased costs and labor shortages. As such, small businesses, in particular, will need to navigate these dynamics to leverage potential benefits while mitigating associated risks." - Lance Roberts, The Bull/Bear Report, SimpleVisor
Corporate earnings tend to be inversely correlated with energy prices and inflation:
The chart below is courtesy of Torsten Slok from Apollo.
We believe we are in for lower energy prices around the world. In the past, the OPEC nations started a price war to maintain pricing power. This came at a tremendous cost to the US. Energy corporations went bankrupt, and consumers all over the world paid a lot more. Now, the US energy sector is in much better financial shape to withstand a price war, has invested heavily in technology, and has driven down the breakeven price for oil to well under $50.00 per barrel. A number of companies have significantly lower breakeven prices as well.
Furthermore, we have a surplus of natural gas we can ship to the world. The US domestic cost is $2 – 3/mcf (million cubic feet). Europe pays an estimated $12, while Asia pays an estimated $13 at this time. If it is a cold winter, prices can spike to $20. Quite simply the US is the largest exporter of natural gas worldwide.
Lower energy prices benefit all economies globally due to energy being a key component of production costs.
Inflation in real life is difficult to control unless one is continually vigilant. Here in the US, we relaxed our vigilance on inflation due to Covid. The unknown fear caused tremendous uncertainty, which the US government and the FED combatted with historically low interest rates and monetary stimulus.
The problem was that the FED did not recognize why inflation was so high until well after it was too late. They then started a rate hiking cycle to slow the economy down. Currently the economy is doing well, and while the FED just cut the benchmark interest rate on Dec 19, 2024, the next interest rate movements will be flat in our opinion. We do not want to see interest rate cuts until we are very sure inflation is under control. I (RM) all too well remember inflation getting out of control in the 1980’s and FED Chairman Volcker raising interest rates to 15% and forcing a severe recession. Why do I remember so vividly? I had just graduated and could not get a job!
We see the following as clouding the situation as to why the FED will not lower rates:
Remember, the FED has a dual mandate, low inflation and low unemployment. One could say two forces working against each other.
As always, we live in interesting times.
We thank you all for taking the time and reading “Market Watch.” It is meant as an educational piece on the always evolving markets. It is something we plan on providing every month, and your feedback is very important to us.
On a personal note, RMH is now in the position to bring on new clients so please be sure to share this informational letter with whomever you wish. RMH’s focus is on the customizable investment needs of individuals, families, and foundations. We enjoy working with our clients to better understand their goals, values, and passions for what is important in their lives. In expanding our client base, we look forward to working with people who share these same desires.
Richard Mundinger, CFA
Ashlyn Tucker, M. Fin, Analyst, CFA Level III Candidate