Outlook for financial markets heading to the end of 2025

Key Concepts

• Bull Market: A sustained period of rising stock prices.
• Federal Reserve (Fed): The central banking system of the United States, responsible for monetary policy.
• Rate Cuts: Reductions in the interest rates set by the Federal Reserve, intended to stimulate economic activity.
• Earnings Growth: The increase in a company's or market's profits over a period.
• AI (Artificial Intelligence): Technology that enables machines to perform tasks that typically require human intelligence.
• Capital Expenditure (CapEx): Funds used by a company to acquire, upgrade, and maintain physical assets such as property, buildings, and equipment.
• Monetization: The process of converting something into money.
• Cash Flow: The net amount of cash and cash-equivalents being transferred into and out of a company.
• Volatility: The tendency of a stock or market to fluctuate significantly in price.
• Hawkish Fed Policy: A monetary policy stance that favors higher interest rates to combat inflation.
• Dovish Fed Policy: A monetary policy stance that favors lower interest rates to stimulate economic growth.
• S&P 500: A stock market index representing 500 of the largest companies listed on stock exchanges in the United States.
• GDP (Gross Domestic Product): The total monetary or market value of all the finished goods and services produced within a country's borders in a specific time period.
• Yen Carry Trade: An investment strategy where an investor borrows in a currency with a low interest rate (like the Japanese Yen) and invests in a currency with a higher interest rate.

Market Outlook and Fed Policy

Brad Bernstein of UBS Private Wealth Management maintains a bullish outlook on the US markets, believing the bull market is intact. He projects the S&P 500 to reach 7300 by June and 7700 by the end of the year. This optimism is driven by three key factors:

1. Further Fed Rate Cuts: Bernstein anticipates at least two Fed rate cuts by the end of the first quarter (March 31st). He notes that the odds for a cut are currently around 77%, a significant increase from Thursday's 30% following dovish comments from Fed Vice Chair John Williams.
2. Continued Strong Earnings: The market is expected to benefit from ongoing robust earnings growth.
3. AI Growth Story: The advancements and adoption of Artificial Intelligence are seen as a significant growth driver.

Impact of Fed Rate Cut Uncertainty

Bernstein highlights that recent market volatility, particularly the sharp reversal on Thursday, was likely triggered by the delay in the November jobs data announcement, which pushed it past the December 10th Fed meeting. The subsequent dovish comments from John Williams on Friday helped to stabilize and turn markets around. He emphasizes that for markets to experience a smoother ride, there needs to be greater clarity and understanding of the Fed's policy direction. A failure to deliver a rate cut on December 10th would likely lead to further volatility.

The AI Revolution and Monetization

Artificial Intelligence is identified as a major catalyst for market growth. While NVIDIA's recent earnings were strong and better than expected, the market reaction was initially negative. However, Bernstein points to a broader trend of increasing capital expenditure (CapEx) in AI for the upcoming year. More importantly, he emphasizes the clear evidence of AI monetization happening across various sectors.

• Enterprise Software: Computer-facing applications are generating revenue.
• Cloud Platforms: Leading cloud providers are reporting increasing revenues.

Bernstein stresses that the critical next phase of AI growth is the development of a positive cash flow and profitability story, not just the spending. This monetization is crucial for the continuation of the current rally, as it addresses concerns about sustained growth and profitability. While not every company in the AI space will be a winner, the overall narrative remains strong with increasing spending and emerging profits.

Broader Market Performance and Opportunities

Beyond Big Tech and AI, Bernstein notes that the broader market is also showing encouraging signs.

• S&P 500 Earnings Growth: The median earnings growth rate for the S&P 500 in the third quarter was over 5%, exceeding the norm. Overall earnings for the year are projected to be up around 11%, with a 10% increase anticipated for the next year. This broad-based earnings growth is seen as a positive indicator for the upcoming year.

International Market Opportunities

Bernstein also highlights attractive opportunities in international markets:

• Europe: UBS has upgraded Europe to "attractive" for next year. A key catalyst is Germany's significant spending on infrastructure and defense, estimated at 20% of its GDP. This spending is expected to drive growth in Europe through 2026.
• Japan: Japanese markets are also favored. The impact of Japan's monetary policy on global markets, particularly concerning the Yen to Dollar exchange rate and interest rates, is significant. The Yen carry trade, which has historically impacted global markets, is a relevant factor.

US Domestic Sector Preferences

Within the US, in addition to the broader market, Bernstein likes the following sectors:

• Financials
• Healthcare
• Utilities

Conclusion

The US markets are poised for a positive opening, with a strong belief that the bull market remains intact. This optimism is underpinned by expectations of further Federal Reserve rate cuts, continued robust earnings growth across the board, and the accelerating monetization of Artificial Intelligence. While volatility may persist due to policy uncertainties, the underlying economic and technological trends suggest a favorable outlook for the coming year, with attractive opportunities also present in European and Japanese markets, as well as specific US domestic sectors.