Walking and Chewing Gum in 2025
Get comfortable, we're going to be here a while… This one is a little longer than usual.
Thank you for reading, and I really hope it helps you think about what's ahead.
2024 was another tumble-cycle kind of year, in terms of the economy, markets, and geopolitics.
We'll dive into some of the play-by-play below, but if your head is spinning, I get it. While predictions are generally unhelpful on a good day, there are plenty of reasons to expect that 2025 will be no different.
Last year around this time in January, I talked about how I think about making decisions under uncertainty. That's what I was trained to do as a Ph.D. financial economist and what I've been paid to do ever since joining an elite family office in NYC minutes before the 2008 financial crisis really got going (My first day working in risk management for the Ziff family was June 15, 2008. My timing was impeccable. I am grateful daily for that experience and for everything that it led to, including having our kids in New York City and making lifelong friends along the way).
Here is what I wrote then:
“Given that making one-and-done predictions doesn’t seem like the wisest way to operate in this world, here is a framework for making decisions when the future is unknown. It’s a simple model, which means it has “long shelf life,” as my former teacher, boss, and Nobel Prize winner Bob Merton would say. Simply put, for anything that matters to you, sort out three scenarios:
Very bad
“Another day at the office”
Very good
For each of these scenarios, work out what things may look like and what reasonable odds of each are. When that’s done, make decisions that:
Don’t look silly in the most likely scenario (Nobody wants to look silly when the “obvious” happens…)
Don’t look naïve in the second most likely scenario (That’s the basic difference between amateurs and professionals)
Don’t blow you up in the third scenario (That’s called risk management)”
The full piece is Seeing Around Corners?
As an aside, my most likely scenario then is roughly what we got, though that barely matters... The point is to be prepared for many different scenarios. Expect to be wrong. But here is what I thought then:
“At this point, not being weird looks like the much-heralded “soft landing” that the Fed has been hoping for. Despite it being a rare feat (based on the historical record of modern central banking), it looks like the most probable scenario, and it happens to be the “another day at the office” scenario. How grand would that be, huh?
The economy would slow a little (It rose 2.5% in real terms for the whole of 2023)
Workers would get a little less comfortable (Wage growth would cool and, net-net, unemployment would go up)
We would avoid an outright blowup on commercial real estate (Time would be on the side of orderly workouts, though refinancing the 1 to 2 trillion dollars of CRE loans coming due would make for late nights and long weekends)
As far as residential real estate is concerned, we would see more activity, and get a better sense of what “true prices” are
Oh, and inflation would keep coming slowly, but with a good amount of volatility around the landing path
Given where interest rates are at this point, the soft-landing scenario is one that favors long rates staying roughly where they are and short rates coming down (but not as much as the market is hoping), allowing the yield curve to revert to something that looks more normal (read: “steepen,” in Wall Street talk).
The big one is volatility in equities and spreads on risky debt. Those have been recently low relative to history. We should hope that the soft landing comes with a relatively mild return to more normal conditions: somewhat higher equity volatility and wider spreads on risky bonds (Right now, it looks like the direction of travel on spreads is in the opposite direction, given the amount of money chasing a limited number of deals in debt-land, but that’s the point of laying out the scenarios, to know where the world conforms and where data points in a different direction).”
The hard facts are that the economy did shockingly well in 2024.
We're still waiting for Q4 numbers, but GDP grew nicely, unemployment moved up but didn't explode (which wasn't clear to me mid-year), and inflation continues to grind lower—but does so on its own frustrating timetable. 2025 will be the final exam on inflation. Domestically, there are plenty of reasons to worry that inflation could rear its ugly head (higher tariffs, never-ending deficits, etc.), but the global picture suggests that we may be seeing more deflation out of places like China, and lower energy prices (at least in dollar terms) if global macro gloom persists.
Before we get into the markets side of things, I am reminded of something else I wrote about a year ago about market volatility and what I call superstition…
“I want to repeat something important from above. The US economy has been very resilient, and things have been very good out there: Jobs, economic growth, even productivity has been a bright spot (Apparently everyone finally learned how to do the job they were hired for in a hurry after COVID recently). In fact, there is a strong case for the possibility of a good economy going forward.
So it’s not overly tenable to make the case for bad things in the future just because we have good things now (That’s called superstition, which is not a preferred mode of analysis). Let’s get a little more analytical than that.
What has it looked like out there when the Fed has cut rates in the past? A good barometer for the financial weather is volatility, particularly the kind that’s used to price options. When sun shines on markets, volatility tends to be low. When there is a storm in markets, volatility is high. Let’s look at data going back to the early 1990s with the VIX (the index for implied volatility on the S&P 500) becomes available. In red (left scale) is the Fed Funds rate, and in blue (right scale) is volatility. With the exception of the early 1990s (the last “soft landing,” and the only such soft landing in the last 60 years), every time it cuts, the Fed tends to cut a lot over a short period of time — because it sniffs out that the economy is slowing down hard — and that’s followed in short order with a jump in volatility. Some spikes are smaller like 1998 or the early 2000s and some spikes are historically large, like 2008 and 2020.”
This is from: "Say Hello to 2024 and Say Farewell to 'T-Bill and Chill'"
The volatility thing is really important and may dictate what happens next.
We had two very short-lived but fairly violent volatility spikes this year—in early August, as the Japanese carry trade went kaput and in mid-December, when Jay Powell had the least convincing Fed press conference in recent history and told us that inflation forecasts had "kind of fallen apart."
Those spikes were violent. This is likely caused by the growth in zero-day-to-expiry (0DTE) options. These things are the closest thing we have to financial scratch tickets and may be adding instability to the market (Thanks, Wall Street for your “product innovation.” We appreciate you and your drive to improve communal outcomes… j/k, not really). To the extent that some of this is real uncertainty and some is changing market micro-structure, it is reasonable to think that the next volatility spike could be as violent and possibly more. The real test will be whether it lasts a day, a week, or a month. If we get closer to the month mark, then we get pretty close to “go time” on real financial strain and on the Fed pulling the rates lever hard and downward.
This is not superstition, this is experience and understanding of how risk works. It tends to build under the surface and eventually breaks through the shell and into plain sight, not unlike magma pushing out and through the cap of a volcano.
Ok, more charts…
I know, you don't like them but there is something to learn here.
Focus on the action in this chart way to the right of the horizontal axis (the rest is for context).
In November of 2023, the 10-year Treasury rate was north of 4.5%. That was pretty spicy for a lot of people. It came down hard to 3.8%, roughly, by December. It then managed to go back to 4.6% in April as inflation was giving us a head fake upward. Once it became clear that inflation was stable and that employment was cooling (as expected in a soft landing), rates started falling hard… By September, as the Fed was starting to cut short-term rates, the 10-year rate came down to 3.6%, and then everything changed: the economy stabilized, employment started looking like it had a floor, and the "Trump trade" hit the scene. Expectations of "more growth, more deficits, more inflation" meant higher yields. On the ground, this has also felt pretty violent, and if we get closer to 5%, there is a reasonable argument that we're in for a proper market freak-out (technical term, obviously).
Here is the key point… Note how all of this excitement is happening within a narrow range that looks kind of normal (also technical talk) relative to what we've seen as recently as the mid-2000s. My point is simple, the rate isn't "the problem," the problem is that people got used to operating in a 2-3% range, took on leverage or consumed credit by the ladle not the spoonful. Some of that is starting to look like it was "silly" (i.e., only made sense in a low rate environment) and this is where we're facing a fork in the road: to the left, pain and disruption if we stay stuck with higher rates, to the right, a recognition that the system "needs" lower rates and lower rates must be engineered. This is a rock and a hard place situation. Nothing good comes from engineering unnatural and unsustainable conditions because at some point, you must pay the piper (it's all a subsidy—in this case turning private losses now into larger public losses later). I don't know what you think, but that's not a happy tradeoff.
If you want to know what concerns me, I'll tell you. It's that some prices don't have a lot of room for error in them. On the one hand, that's understandable—the market favors the optimists (over the long haul and most of the time in the interim), and there is efficiency in that. On the other hand, what do you make of the super-duper narrow extra reward for credit risk? See the graphs below, the current interest rate on risky corporate debt doesn't give you much of a buffer if we get serious losses and defaults. The market is saying "don't worry about it." Maybe, but then again, maybe worry a little, still?
And then, there is the stock market…
Large US stocks, in particular. This is the BIG ONE. And this is where "walking and chewing gum" comes into play. This is where two things can be true at the same time. "People" (I mean, non-economists) accuse economists of always equivocating, of saying "on the one hand… but on the other hand" too much. Don't you hate it when people call you out on your "smelly stuff?" I agree. But you see, financial economists (people like me) have a special trick to deal with this situation. We call it "prices." Repeat after me: prices.
Prices have got to be relative to something so you can assess the odds that the "price is right." It's all probabilistic — you don't know if the price is right, just how much room for error there is in the price. In business terms, can things go badly and you still eke out a decent outcome? When it comes to stocks, we talk about earnings: how much the business spits out in terms of profits that belong to the shareholders. Stocks trade relative to earnings (and expectations for future earnings).
Yes, the US corporation is a master at creating earnings and earnings growth, certainly relative to other places like Europe. It is also true that we have de facto monopolized the tech space here in the U.S. (with some exceptions, of course) and that technology has been relentlessly "eating the world" over the last couple of decades. All true. And yes, the AI revolution has been propelling those world market leaders forward at a pace that makes it hard to wrap your head around the numbers. See this graph from Michael Batnick at the Irrelevant Investor.
The growth in earnings for Nvidia (which makes AI chips) has literally taken off like a hockey stick. That's why the growth in the stock price. Not crazy, on the face of it. But does this go on forever? That's question number one. And are investors pricing the stock like this will go on forever? That's question number two. I worry about what I don't know, and I don't know the answer to this.
I saw what happened the last time the blue dots dipped below the white dots, back in 2022. I was right there. It was not pretty.
But at the time, Nvidia was not Engine No. 1 for the whole market. And I worry that people are forgetful, particularly about the fact that two things can be true at once, and that price is often the deciding factor. I learned this early, when I was studying the great bubbles in history with Earl Thompson at UCLA. The argument is often "new technology" and it's often valid.
Maritime travels and commerce (and colonial extraction of wealth) did change the world, and still the South Sea Bubble was... well, a massive bubble.
The internet changed the world like nothing we've seen in a long time, and still the frenzy that took us to the early days of 2000 means that an entire generation of investors lost huge sums in a matter of months after the Tech Bubble burst. Yes, time made it right, and then some, but that's where the question sits.
And the answer is personal, based on your circumstances, needs, and psychological makeup. Pretend, just pretend that US stocks are overvalued and that the euphoria recedes. Maybe a crisis precipitates this along. Pretend that those great companies continue to do great things, but that their stock prices fall a lot, and that the market is down 30%, maybe 40%. Do you have the wherewithal, financial and psychological, to sit there and wait to see what happens, and hopefully make up those losses over time? I repeat, I cannot know that for you. This is a personal question. And I am not suggesting that you should live your life like this will happen. Because we don't know what will happen. As Yogi Berra famously said: "Predictions are hard, especially about the future."
But as we enter 2025, a little introspection can go a long way into providing peace of mind. Maybe the market continues to live in the golden era of the last couple of years and companies continue to grow earnings in a way that satisfies investor expectations. Maybe. In fact, that seems like a reasonable baseline for the long run. Anything else is akin to betting against humanity, enterprise, and the pursuit of progress. But near term, bad things happen. It’s nice to know that you could handle them.
And that takes us back to the framework that I opened with.
For anything that matters to you, sort out three scenarios:
Very bad
“Another day at the office”
Very good
For each of these scenarios, work out what things may look like and what reasonable odds of each are. When that’s done, make decisions that:
Don’t look silly in the most likely scenario (Nobody wants to look silly when the “obvious” happens…)
Don’t look naïve in the second most likely scenario (That’s the basic difference between amateurs and professionals)
Don’t blow you up in the third scenario (That’s called risk management)
With that we may be able to walk and chew gum at the same time, and welcome whatever 2025 brings us.
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Treussard Capital Management LLC is a registered investment adviser. The scenarios discussed in this article are hypothetical and not predictions of future market performance. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and loss of principal is possible. Investments are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance. Please visit www.treussard.com for more information about Treussard Capital Management and for important disclosures.