Sometimes things don’t always go according to plan. An unexpected car repair can blow the monthly budget. A lingering illness can delay completing a big project.
When it comes to the schemes of central planners this is especially true. A five-year plan may list certain goals and objectives. It may even outline a roadmap for achieving them. But reality has a way of taking things off their intended course.
The Federal Reserve commenced its rate cutting cycle on September 18, when the yield on the 10-Year Treasury note was about 3.70 percent. Since then, and in the face of a full 1.00 percent in Fed rate cuts, the 10-Year Treasury note yield is now at 4.60 percent. The Treasury market, as represented by the 10-Year note, is diverging from Fed rate cuts.
One possible reason is that the Fed made a mistake when it declared ‘mission accomplished’ in its fight with consumer price inflation. The Fed thought the moderating rate of consumer price inflation would continue. That it had set the trajectory of prices, and before long they would fall in line with its arbitrary 2 percent target.
The core personal-consumption-expenditure (PCE) index, which excludes the price of food and energy, was recently reported to have increased at a rate of 2.8 percent over the last 12 months. Once again, the Fed has been wrong about inflation and must change its plan.
For example, the latest FOMC dot plot is now projecting two rate cuts in 2025. This is down from the four rate cuts that were forecast in the prior dot plot. Perhaps FOMC members, like 10-Year Treasury note investors, have realized that elevated consumer price inflation is here to stay.
But what else could be going on?
Headwinds Blowing through Europe
Persistent levels of elevated consumer price inflation suggest interest rates should remain higher. This is in agreement with recent movements in 10-Year Treasury yields. It is also driving the Fed to recalibrate its rate cutting plans.
But what if FOMC members and Treasury investors are missing something? What if they’re missing the cause and effect of the economic headwinds blowing through Europe? What if burgeoning recessions in Germany and France will serve to pull Treasury rates down in 2025?
This was the opinion shared this week by Louis Navellier, of the family office Navellier & Associates. Navellier posits that:
“The global interest-rate collapse is just beginning. Specifically, the European Central Bank will be cutting key interest rates four or five times in 2025 until rates are at 2% to 1.75%. Most Fed watchers and the FOMC itself do not yet foresee all of these global dominos falling, as the recession in the eurozone’s largest economy, Germany, gets worse. The second-largest economy in the eurozone, France, is also slipping into a recession.
“Falling interest rates around the world will trigger capital flight into U.S. Treasurys, driving those yields down. Since the Fed never fights market rates, I am confident that central bankers will cut its key interest rates in the U.S. four times in 2025.”
If Navellier is right, this means interest rates would fall in 2025 even as consumer prices inflation remains elevated. Lower interest rates generally encourage more borrowing and spending. Moreover, the effects of lower interest rates often bubble up in stock market prices.
What to make of it?
Significantly Overvalued
The major U.S. stock market indexes are already at bubble prices. The idea that these bubbles could expand even further in 2025 is completely irrational.
A look at the S&P 500 shows that the broad market index is near its all-time high. In fact, the S&P 500 hit over 50 record highs in 2024. Year-to-date it is up 27 percent.
However, looking at only prices presents an incomplete picture. The real question is does the S&P 500 have the earnings to back up its sky-high prices?
The S&P 500’s current valuation, when compared to its historical valuations going back to 1871, reveals a stock market with significant risks. The Cyclically Adjusted Price Earnings (CAPE) ratio is 38.35.
That’s over 123 percent higher than the CAPE ratio’s long-term historical average…and well above the 32.56 CAPE ratio reached in September 1929. The only times the CAPE ratio has been higher was for a brief moment at the dot com bubble peak, in December 1999, when it hit 44.19, and in October 2021, when it hit 38.58.
Following these CAPE ratio peaks – September 1929, December 1999, and October 2021 – the stock market sold off. The first two were spectacular market crashes. The more recent selloff resulted in the 2022 bear market.
In short, based on the current CAPE ratio, the S&P 500 is now priced at well over double its historical average. The NASDAQ and DJIA are also both at nosebleed levels.
Similarly, the Buffett indicator, which is a ratio of the total market capitalization over gross domestic product, shows that the overall stock market is significantly overvalued. The ratio currently stands at about 206 percent.
A fair valued market is a ratio somewhere between 108 and 132 percent. Anything above 156 percent is considered significantly overvalued.
Expect the Unexpected in 2025
The most reliable way to make money in the stock market is to buy low and sell high. Conversely, buying high and selling low is a guaranteed way to lose money. Based on current valuations, buying the major U.S. stock market indexes right now would be buying high.
Perhaps you could buy high and sell higher. While completely irrational, it is possible the stock market bubble could expand further. Remember, bubbles, by definition, are irrational.
Regardless, buying high in the hopes of selling higher is not an advisable way to invest. Not unless you consider gambling to be investing.
Successful long term index fund investing requires buying when the market index is cheap – when the CAPE ratio is below 15 or the Buffett indicator is below 84 percent.
Based on the CAPE ratio and the Buffett indicator, the U.S. stock market is significantly overvalued. But if Navellier is right, the stock market could be further inflated in 2025 by capital fleeing European markets for the USA and central bank credit pumping.
What this means is that as we commence the New Year, there could be a manic melt up in the major U.S. stock market indexes. What’s more, this melt up could be especially spectacular. So, too, the risk of a spectacular crash has rarely been greater.
Thus, our advice for the New Year is to expect the unexpected in 2025. A manic melt up. A spectacular crash. Both. Neither. It could all happen in 2025.
Holding a small portfolio of dividend paying stocks with predictable earnings, along with a higher weighting in cash is a prudent approach. And, of course, possession of physical gold and silver bullion coins as protection against both inflation and a financial crisis is vital given the stress in the financial system.
It’s gonna be a wild one.
Happy New Year!
[Editor’s note: Have you ever heard of Henry Ford’s dream city of the South? Chances are you haven’t. That’s why I’ve recently published an important special report called, “Utility Payment Wealth – Profit from Henry Ford’s Dream City Business Model.” If discovering how this little-known aspect of American history can make you rich is of interest to you, then I encourage you to pick up a copy. It will cost you less than a penny.]
Sincerely,
MN Gordon
for Economic Prism
