January Market Commentary: Bulls, Bonds & Political Risks

Written as of February 10, 2025.

Highlights this Month

• Rising bond yields signal a potential secular shift that demands attention.
• The economic environment will determine both bond yields and stock price trajectories.
• Rapidly rising rates often lead to market declines, but context matters.
• Magnificent 7's AI investments face growing scrutiny as return on capital questions emerge.
• Corporate earnings growth remains robust despite already stretched valuations.
• Business sentiment soars while insider actions tell a more cautious story.
• American exceptionalism continues to reward many investors despite challenging historical trends.
• Canada faces unique vulnerabilities in Trump's trade approach.
• In times of uncertainty, focus on economic fundamentals rather than superstitions.

January in Review

Despite a relatively weak finish to 2024, the market environment facing investors at the start of 2025 continues to look bullish. Big Cap U.S. stocks remain a top choice, with clients polled by Goldman Sachs picking the U.S. market as their overwhelming favourite gain in 2025. Equity positioning, especially in the U.S., remains positive, with most sentiment indicators heavily tilted towards a "risk-on" position (Figure 1). However, market exuberance does not appear to extend to the bond market, with the number of current bond bulls being very scarce at only 15% versus the 10-year percentile (Figure 2). 

Figures 1, 2

January returns largely delivered on expectations, with regional performance varying. 

Looking more closely at returns, market sentiment as reported at the beginning of the year largely delivered in January. The S&P/TSX returned +3.5% (total return in Canadian dollars), while the S&P 500 was +2.8% (total return in U.S. dollars). The NASDAQ trailed with a still respectable +1.7% return (total return in U.S. dollars). International markets performed even better, particularly the German DAX at +9.2% (total return in EUR) and the U.K.'s FTSE at +6.2% (total return in GBP). 

While the Nasdaq's underperformance deserves attention, it's the bond market and rising 10-year yields that warrant closer examination. The 10-year Treasury yield continued its sharp ascent in the first part of January, and although yields fell back to where they ended 2024 by month-end, their trajectory will be pivotal for markets in 2025. Yields have been climbing for several months, but only recently has this increase started to negatively impact stocks. President Trump's disruptive influence, evident in the flurry of activity from Washington last month, will also play a significant role. 

Rising bond yields signal a potential secular shift that demands attention. 

We highlight rising 10-year yields not just because of last month's trading action but because the trend of the past several years appears to signal a secular upward shift (Figure 3). Last month's increase is particularly noteworthy as it perpetuates an unusual trend of higher rates during a Fed easing cycle. Normally, we would expect rates to continue drifting lower after the Fed starts cutting rates, though rising 10-year rates after the beginning of a Fed easing cycle isn't unprecedented. 

Figure 3

Similar moves occurred in 1981, 1995, and 1998 (Figure 4). In 1995 and 1998, rates rose because the Fed eased into a non-recessionary economy where economic growth could accommodate higher rates (a "soft landing"). In 1981, it was because the Fed reduced rates prematurely before inflation was under control. 

Figure 4

The economic environment will determine both bond yields and stock price trajectories.

The economy plays a crucial role in shaping both bond yields and stock prices. If the economy is strong but not overheated, and gradual monetary adjustments lead to a soft landing, 10-year yields can continue trending higher without causing too much economic damage. Alternatively, if the Fed needs to pivot from easing back to tightening because inflation remains too high, a hard economic landing becomes more likely. (Figure 5) In this scenario, 10-year rates would likely begin moving lower, but prices for most risk assets would come under pressure.

Figure 5

U.S. debt sustainability concerns may be driving term premiums higher. 

A third factor could be pushing rates higher: growing concern over the sustainability of U.S. government debt. The rise in 10-year yields has largely resulted from an increase in the term premium—the additional compensation investors demand for lending to the U.S. government long-term versus rolling over short-term T-bills (Figure 6). According to PGIM's Gregory Peters, this recent rise in term premium stems from the U.S. budget deficit, as increased supply of U.S. debt is expected to struggle with demand, requiring higher yields to attract buyers (Figure 7). 

Figures 6, 7

Higher yields will make incoming Treasury Secretary Scott Bessent's job of stabilizing U.S. debt-to-GDP levels even harder. Bessent's goal, which he refers to as his "3-3-3" economic plan, aims to achieve real economic growth of 3%, reduce the budget deficit to 3%, and produce an additional 3 million barrels of oil (hopefully lowering inflation). Essentially, he seeks to keep interest rates well below nominal GDP while implementing moderate budget cuts. Bessent needs lower fiscal spending to keep the bond market happy, but cuts can't be so severe that they push the economy into recession—a challenging balancing act. 

Rapidly rising rates often lead to market declines, but context matters. 

Higher rates aren't good for stocks, particularly when they rise quickly. Bloomberg highlights that periods of rapid yield increases are associated with S&P 500 declines. However, the reason behind rising rates matters. 

If higher rates stem from economic resilience rather than a rising term premium, valuations should remain stable. However, if yields rise amid falling economic indicators and an increasing term premium, stocks will likely face pressure (Figure 8). This was the case in the first half of January before markets recovered in the second half as 10-year yields began declining. 

Figure 8

Magnificent 7's AI investments face growing scrutiny as return on capital questions emerge. 

Also weighing on the S&P 500 in January were the Magnificent 7 stocks, particularly those associated with artificial intelligence and the massive capital expenditures supporting it. Reminiscent of the dot-com bubble, investors increasingly worry the billions of dollars that companies like Microsoft and Meta are spending on AI will fail to generate sufficient returns. Nvidia has benefited from this spending, but some question the sustainability of its growth. 

A recent Nomura chart comparing Nvidia's revenue to Cisco's during the dot-com bubble suggests a steep decline in Nvidia's revenue might be imminent (Figure 9). Cisco's revenue growth essentially flattened after its initial dot-com surge, with its stock price still well below its March 31, 2000, all-time high. 

Figure 9

The math behind Wall Street’s predictions. 

These fears gained momentum when China-based AI startup DeepSeek released a new AI model that appeared comparable to leading U.S. software but was developed at a fraction of the cost. Interestingly, the S&P 500 Utilities sector was hit just as hard, and while both sectors recovered some losses by month-end, trading remains volatile. However, concerns that a decline in these market leaders would trigger a general market correction were largely unfounded.  

Corporate earnings growth remains robust despite already stretched valuations.

With stock valuations already stretched, corporate earnings growth is essential to keep stocks moving higher, and so far, earnings look positive. According to Goldman Sachs, S&P 500 fourth quarter 2024 earnings growth is tracking around 9% versus Wall Street's 8% forecast (Figure 10). Estimates for 2025 have started drifting slightly lower, but this is normal. If anything, revisions for consensus 2025 bottom-up S&P 500 earnings per share are tracking considerably higher than usual. According to Ritholtz Wealth Management, Wall Street is forecasting the perfect year for Corporate America, with all 11 S&P 500 sectors expected to report positive earnings growth (Figure 11). 

Figures 10, 11

Business sentiment rising while insider actions tell a more cautious story. 

Corporate America appears to welcome President Trump's policies. U.S. Small-Business sentiment recorded its largest two-month gain since 2018 in monthly data back to 1986, while Apollo reports CFO optimism about both the economy and their own companies has increased. 

Interestingly, what executives are saying does not align with what they're doing. The percentage of publicly traded corporations experiencing net positive buying from their officers and directors has fallen to its lowest level in at least a decade (Figure 12). Washington Service reports the ratio of insider buying versus selling is on track to reach its lowest level in data going back to 1988. 

Figure 12 

Dollar strength poses a historical challenge to maintaining earnings momentum. 

One factor these insiders might be considering is the strength of the U.S. dollar. Periods of dollar strength have historically been associated with flat earnings growth, and the dollar has been strengthening significantly. The U.S. dollar has returned to levels last seen during the dot-com bubble when tech stock performance versus the S&P 500 peaked (Figure 13). 

Figure 13

American exceptionalism continues to reward many investors despite challenging historical trends. 

So far, betting against American exceptionalism has been a losing proposition. U.S. GDP growth outpaced its G-7 peers in 2024, and the International Monetary Fund believes it will do so again in 2025 with expected real GDP growth of 2.2%. Stocks struggle when real GDP growth falls below 2%, but when growth is between 2.1% and 3.0%, the S&P 500 has delivered a median return of 13.1% and has been positive 70% of the time (Figure 14). Based on statistical evidence, Goldman Sachs Wealth Management believes a shift to higher valuations for U.S. stocks may be underway. 

Figure 14

Trump's immigration and trade policies present significant economic risks. 

So, what could go wrong? While some of President Trump's policies could possibly result in stronger and/or more sustainable economic growth long-term, they introduce considerable uncertainty and anxiety in the short term—something markets dislike. His plans for immigration and mass deportations top the list of concerns. According to the U.S. Bureau of Labor Statistics, about 20% of US workers are immigrants, with over 5 million foreign workers joining the workforce in just the past five years. 

Apollo estimates that 23% of the foreign-born population is unauthorized, which suggests nearly 5% of the U.S. workforce could potentially face deportation. Models constructed by Apollo estimate that deporting just 1.3 million immigrants would lower employment by 1.1% and GDP by 1.2%, while likely increasing wage inflation (Figure 15). 

Figure 15

Tariffs represent another questionable Trump policy. If Trump has a grand strategy for how and why he plans to use tariffs, he hasn't shared it with us. Tariffs can generate much-needed revenue—they were once America's main source of revenue, though not for the past century. They can also serve as both a weapon and a negotiating tool. Trade isn't always fair, and sometimes tariffs help level the playing field. This doesn't appear to be the case with Canada, however. 

Canada faces unique vulnerabilities in Trump's trade approach. 

The U.S. trade deficit with Canada was just under $33 billion in 2023 and is on track to hit about $60 billion in 2024. However, excluding the $90.6 billion in oil and gas Canada exports to the U.S., America would have actually recorded a $58 billion trade surplus with Canada in 2023 (Figure 16). The U.S. has significant leverage over Canada, as exports to the U.S. account for 17.8% of Canada's GDP while U.S. exports to Canada represent a mere fraction of U.S. GDP. National Bank Financial, Bank of Canada and Statistics Canada estimate that a potential trade war with 25% tariffs on Canadian goods, and Canadian retaliation, could reduce Canada's GDP by 6%.

Figures 16

Trade war risks weigh on the Canadian dollar.  

The possibility of a trade war is putting pressure on the Canadian dollar. While the widening gap between Canadian and U.S. bond yields has already weakened the loonie, the threat of tariffs alone may account for nearly a five-cent drop in the CAD/USD exchange rate (Figure 17). While traders are extremely long the U.S. dollar and short most other currencies, the Canadian dollar stands out given how negative sentiment is toward the loonie (Figure 18). Adding to the uncertainty, Trump has strategically targeted Canada during a leadership transition, a period of heightened vulnerability. As a result, economic policy uncertainty in Canada is nearing levels last seen during the pandemic. 

Figures 17, 18

In times of uncertainty, focus on economic fundamentals rather than superstitions. 

Several factors are working against stocks in 2025. As Strategas highlights, the third year of a bull market can be challenging (Figure 19). It's also the Year of the Snake, which Carson Investment Management points out has historically delivered the lowest S&P 500 returns among the 12 Chinese Zodiac signs. To cap it off, the Philadelphia Eagles defeated the Kansas City Chiefs to win the Super Bowl, and as Carson Investment Research also notes, Philadelphia victories in major sports have historically preceded market downturns (Figure 20). 

Figures 19, 20

When positioning portfolios, we believe economic fundamentals matter more than historical patterns or market superstitions. A key indicator to watch is the trajectory of 10-year bond yields. If yields rise due to ongoing economic strength and a soft landing, corporate earnings could support equity performance even as the bull market matures. However, if rates climb in response to persistent inflation, we believe a more defensive approach may be warranted. 

We continue monitoring the administration's approach to America's fiscal position. Treasury Secretary Bessent's management of Treasury supply and demand dynamics will be crucial for bond market stability. His background suggests potential strategic management of these issues, though fiscal policy implementation remains uncertain amid competing priorities and a rapidly evolving policy environment.