What We're Talking About This Week!

• Weekly Market Reset

• Key Economic Reports This Week

• Dividend Landscape

• Market Outlook

Weekly Market Reset

The markets continue to struggle to get out of the gate in 2025. Unfortunately, this doesn’t appear to be just a pullback that comes as part of normal market volatility. Inflation and the data supporting it is becoming a genuine concern for investors and is threatening to keep U.S. equities stuck in neutral, if not pull them down further. That’s likely to be bad for both stocks and bonds, the latter of which is already seeing some damage. Long-term Treasuries are already down 9% since early December, but investment-grade corporate bonds are also trending lower. Junk bonds, however, have been mostly holding their ground over the same period, a trend we’ve seen play out over the past year-plus as credit spreads remain historically low.

The market continues to trade heavily on the Fed and where it’s likely to take policy in 2025. A big beat on the non-farm payroll report for December indicates continued overall strength in the economy, but stocks retreated because it makes future Fed rate cuts that much less likely. Given the resilience of the U.S. economy throughout this cycle and the troubling trend with inflation, I’m beginning to believe that rate hikes may be more likely than rate cuts this year. The Fed Funds futures market is currently pricing in a 0% chance of that happening at any point this year, hanging on to 1-2 rate cuts as the year’s most likely outcome. Investors tend to avoid pricing in adverse outcomes until the point comes where they can’t be ignored. I think there’s certainly a greater than 0% chance of this happening, although we’ll need to see the data continues in its current trend for a little while longer first.

As far as early trends for 2025:

I’m closely watching the comeback in healthcare stocks. Currently, it’s one two S&P 500 sectors that are positive year-to-date (energy being the other). While we don’t want to put too much weight into a week and a half’s worth of trading activity, it’s notable for two reasons. First, healthcare has been in a nearly non-stop underperformance trend for the past two years and this is starting to look more like a bottom than a blip. Second, healthcare is one of the steadiest market outperformers in risk-off environments. If healthcare starts to consistently outperform the S&P 500 here, it could have negative ramifications for the broader market.

The worst-performing sectors and themes to start the year - consumer staples, low volatility, high yield equities and dividend aristocrats. That would certainly argue against any kind of broader risk-off shift taking place here. I think we’re still sitting somewhere in the middle with the strong economy acting as an upward force, but the lack of Fed accommodation acting as a downward one. This week’s inflation report will be important for equities.

Key Economic Reports This Week

As mentioned, the CPI report on Wednesday will be the headliner. On a trending basis, a slight tick higher in the annualized rate to 2.8%, the current expectation, is likely to continue the slow burn trend of higher inflation, but might be unlikely to shake the markets if it comes in as forecast. The more concerning trend is these all too frequent 0.3% increases on a monthly basis in both headline and core inflation. That translates to 3-4% on an annualized basis and is going to be too stubbornly high for the Fed to ignore (thus my case for potential rate hikes in 2025). Some higher base effects in the core inflation calculation are likely to keep that number contained for the time begin, but it’s likely to start trending higher again at its current rate.

Retail sales in the United States are likely to keep showing that consumer spending is healthy. Again, that’s a good sign for the economy, perhaps a bad sign for stocks because it reinforces the Fed narrative. Building permits and housing starts on Friday are at least worth keeping an eye on given how sharply interest rates have risen over the past month.

China GDP and retail sales could create some volatility in the latter half of the week. Consumer consumption has been a long-term weak spot for the Chinese economy and, while we’re very unlikely to see any meaningful signs of recovery, another noticeable improvement would be good to see. A rebound to the government’s 5% GDP growth rate is expected, although I don’t think this is a sign of recovery yet.

Dividend Landscape

Even though U.S. stocks are looking more cautious to start the year, that hasn’t translated into any kind of outperformance for dividend payers. Both high yield and dividend growth are among the worst performing factors year-to-date and that’s clearly going to give this group trouble. Considering that cyclicals (except for energy) are beginning to underperform and we have yet to see any kind of consensus leadership from defensive sectors (staples, in particular, are still looking quite weak), this hasn’t been any kind of environment conducive to dividend outperformance.

The rebound in healthcare is, however, a good sign. This sector has largely been missing for the last two years and could provide some important support for dividend stocks. I do believe that a steady risk-off trend in equities like we’re seeing in the market right now would be a long-term positive for dividend stock relative performance at the margins, but it looks like it could still take some time to get there. The transition to the Trump administration, this week’s inflation report and the Bank of Japan meeting all later this month could be catalysts to accelerate a risk-off trend.

Market Outlook

The market is already pricing in greater inflation risk and a lack of action from the Fed. If this week’s inflation report confirms that this trend is continuing (or worse, comes in higher than expected), I think the overall negative sentiment in U.S. equities and bonds will continue throughout January.

The upcoming inauguration of president-elect Trump is bringing closer the potential implementation of economically-negative policies, especially tariffs. If those become an early term priority, expects stocks to not handle it well. A rate hike from the Bank of Japan later this month would also likely be a negative as it renews fears of an August repeat of the reverse yen carry trade.

All in all, there are plenty of landmines to navigate yet this month. Most of them have the potential to be negative and with sentiment already showing signs of negativity, I think the trend of January weakness is more likely than not to continue.

Looking better for: magnificent 7, healthcare, T-bills, U.S. dollar

Looking worse for: long-term Treasuries, small-caps, China, British pound