The Market’s Biggest Risks and Opportunities in 2025 — ft. Tom Lee

24:56And he lists some ridiculous vodka competition. And I'm going to charge 70 bucks a bottle, Grey Goose. And everyone started ordering Grey Goose. And I used to do a taste test in my business school class. And I'm like, how many people think they understand the difference between vodkas? And, you know, all the dudes raise their hand. and I do a taste test. Sounds like hazing. I love it. And no one had any fucking idea. Vodka is such a non-complex alcohol. By the way, it's the Alcoholics Alcohol. I can't smell it on your breath. But double the price and it sends a signal. And this is sending a signal.

25:29And I got to think if you're, if we were a profit, if I was still running a consulting or an analytics company, we would have been signing up for these things everywhere. Because if you think it's$200, it's like, wow, there must be a there there, right? And if you're B2B, 200 bucks doesn't mean anything. If you're the partner in a law firm and you haven't figured out the new AI-specific legal, you know, LLM, you want an edge, right? And this is saying, we're the leader. We are Grey Goose Vodka. We'll be right back after the break for our conversation with Tom Lee. And if you're enjoying the show so far, be sure to give Prof G Markets a follow wherever you get your podcasts.

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28:26Welcome back. Here's our conversation with Tom Lee, co-founder, managing partner, and head of Research at Fundstrat Global Advisors. Tom, thank you very much for joining us on ProfG Markets. Thank you for having me. So you just published your outlook for 2025. And I think on this episode, we just kind of want to go through everything that you're predicting, all the trends that you're observing, and we'll kind of just go through them one by one. So the first is a pretty large prediction. You say that this will be a tale of two years. And then in the first half of the year, you see the S &P hitting 7 ,000.

29:03But then by the year end, you see it falling back to 6 ,600. So let's just start with a walkthrough on all of the factors behind that prediction. Glad to. As we look forward to 2025, I think that the fundamental visibility is much better than it was at the start of 2024. meaning we have a Fed that's dovish, and I'd consider that a Fed put. We have the election behind us, which was really a source of angst in 2024, and the incoming president is very pro-equities, so I'd call that a Trump put. That's a tailwind. We know businesses have been cautious for the last two and a half years because of the combination of the pandemic and the repercussions on the labor force, plus the inflation wave, plus a Fed that was trying to quash inflation.

30:02So I think animal spirits return. So these are the tailwinds that are positive for equities in 2025. But the drawback in our view or the headwinds that emerge is one, there's a lot of promise about potential initiatives in 2025 that I think become markets have to reckon with it. I think that comes in the second half. There is also a valuation. You know, the stock market is more expensive than it was two years ago. So the markets may be a little less patient if there are any stumbling blocks. And the third risk, you know, in the second half that emerges is that there are things that markets will start to worry about, like deficits and the potential ending of the business cycle in 2026.

30:48So I think that those are the things that weigh on markets in the second half. It's almost like there's all this optimism happening, and then it sounds like at some point next year, reality is going to set in. And the thing that you mentioned there is, you know, a lot of optimism around initiatives. What kinds of initiatives are you describing there? I assume these are Trump policies that the market is expecting will boost the economy in some way. Yes, I think some of the initiatives have a lot of positive potential. Others carry with it risk. You know, and the things that carry risk is how the economy will be affected by mass deportations if that happens.

31:31the notion of tariffs you know tariffs can be an important tool but tariffs can be very disruptive to a global economy and then there's also doge the department of government efficiency that i think if if we were in a crisis moment doge could be extremely effective but at the same time tackling government spending is something that I think is extremely difficult and fraught with visibility risk. And I think it poses risks for companies that are big government contractors. So that's what we have to watch. And then the other thing I think that really bears watching is Bitcoin, because I think there is a lot of policy that's being built around Bitcoin finally being more accepted, you know, the sandbox changing for Bitcoin to be something that the U.S.

32:23government potentially embraces. Tom, it's good to see you. I always stop whenever I see you on social. I always stop because I find whatever your thoughts are is worth listening to. Speaking of the U.S. market, 15-year plus bull run, 50 % of the world's market cap now represented by U.S. stocks. And if you believe, as I do, the markets are cyclical. Are we due for a flow out of the U.S. market into international markets? Our research sort of foundation, one of the keys is the idea that history serves as a really important guide. And what I've been struck by is that if I take the U.S. versus the DAX, for instance, any more than 10-year period, the returns, the nominal returns between the DAX and the S &P should be very similar.

33:15and the starting point for non-U.S. markets is a much lower valuation. And in 2025, if we're talking about animal spirits coming back because of central bank easing, and that's a cyclical upturn, well, outside the U.S., there are many cyclical companies, you know, industrials, financials, you know, banks, exporters that should benefit. And so So I'm not opposed to the idea that next year, if the S &P could essentially feel like it's treading water next year, could emerging markets do better? I think so. And, you know, some things to watch are like China, because China is unleashing some stimulus.

34:00And if China is leading, I think it does mean the rest of the world does quite well. And just within our own market, it's been big is beautiful for a while. Wow. Do you think, again, there'll be another reversion to the mean where small and mid-caps will have their day in the sun? I'm in the camp that next year it's less about the MAG-7. I think the MAG-7 will produce good earnings growth, and so that's going to support valuations not contracting for the MAG-7. But to me, the case for PE expansion and earnings surprise is coming more from the mid-caps and the small-caps. I mean, for instance, if the Fed remains dovish and the cost of capital actually starts to fall, that's going to benefit many cyclical companies.

34:45If there's less regulation and there's M &A, that's less a story about the MAG-7 benefiting, but it's really more about software and a lot of cyclical stocks leading it. Our number one sector pick next year is financials, actually, within the S &P. And then outside the S &P, I think Bitcoin and small caps actually outperform financials. Why financials? Financials play a pretty important role in the economy. They're essentially the other side of the ledger. So for every actual economic event, the financial system has to provide the accounting and markets mechanisms. And next year, we think that there is a lot of opportunity for the economy to see increased activity.

35:34Let's say the PMIs are finally turning up. ISM's been below 50 for almost three years, so it's been the longest industrial recession ever. As that turns up, that means companies become more confident and there's more expansion. Well, that's more financial activity. M &A activity has essentially fallen to multi-decade loads because of a tight Fed and concerns about a recession. As businesses have some pent-up demand and there may be some capital markets activity, well, that benefits financials. And when I look at regulation and the idea of less regulatory burden for companies, one of the industries most positively affected is financial.

36:15So I think there's a lot of cumulative tailwinds building for the financial sector at a time when the PE multiples there aren't that demanding. I know the stocks did very well this year, but I think they're going to do well next year. I want to just go back to the potential downsides with this new administration. You mentioned tariffs there as one of the biggest risks to the market. it. I'd love to just get your sense of how that might play out. I mean, Trump has threatened the BRICS and he's threatened Mexico and he's threatened Canada. There's just this word tariff has been a big word in 2024, but it's not totally clear to me how we can actually model that out in 2024.

36:56So how do you see this tariff story playing out? And this is just a supposition. So I'm going to give you like a theoretical, but But let's say that we took everything at face value so these tariffs get implemented. And this triggers retaliatory tariffs from other countries. And then we have both a volumes effect. So the flow of goods globally starts to slow. So you have weaker growth, plus the actual realized price of goods goes up because U.S. consumers bear the cost of that tariff because these are the cost of imported goods. So you have optical inflation higher and then a weaker economy, which means joblessness goes up.

37:46And then, without question, the stock market would have a lot of pressure because it's hard to make the case that multiples can offset the earnings risk that this presents. So then markets could be correcting for a lot of 2025. If the White House measures its success through how the stock market's performing, that would put enormous pressure on the White House to rethink whether these things are achieving their goal. Because if the White House wants to measure its success through the stock market doing well, I think they'd pretty quickly realize that a tariff war is not popular with Wall Street, even if it's something that as a policy sort of cornerstone, they want to make it as a policy cornerstone.

38:35That's just a supposition because, of course, I'm not a White House insider. Yes. And the other side of this you mentioned there is that people are putting a lot of faith in the Treasury Secretary, Scott Besant. He's been nominated and Commerce Secretary, which would be Howard Lutnick. Is it because those guys are Wall Street guys and so Wall Street believes they're probably going to be on Wall Street's side? So much of what anyone wants to accomplish in the economy or even as policy does require the cooperation of financial markets. And that's because, as you know, the Fed itself is quite afraid of the bond market.

39:10You know, the Fed never really wants to make a policy shift that the bond market would be surprised at because then that could actually run counter to their goals. So that's why when the Fed's cutting and if yields start rising, the bond market's clearly sending a signal that they don't want too much easing. So there is an equilibrium that someone with Wall Street experience can appreciate. And I think I would counter that by, you know, so many people think policy should be driven by economists. And I think one of the challenges over the last three years that I found as working with institutional investors is that over the last three years, so many of our institutional investor clients began to rely more and more on their economist to give them an idea of what the future looked like.

40:03And as you know, economists rarely can tell you what will likely happen. They can tell you the effects of what has already happened. And I think one of the things I'd be very worried about is someone trying to drive policy purely from an economics perspective. So I'd rather have someone with markets experience telling you that this is where markets could actually protest. And that's what can keep policy in check. That's very interesting. Sort of the decline of the PhDs in the administration. And this, I mean, this cabinet's been packed, filled with investors versus professors, which is an interesting dynamic.

40:39Yes. And one measure that, by the way, and this is a side note, is that the compensation of economists on Wall Street rose dramatically over the last three years because every hedge fund wanted to know how to parse and interpret the Fed and economic data. But a lot of these economists ended up providing insights that were forward-looking that proved to be very disastrous for many institutional investors. We'll be right back. And if you're enjoying the show so far, hit follow and leave us a review on ProfG Markets. Stay with us.

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42:58We're back with Profit G Markets. Your thoughts on Bitcoin, its price escalation, and if and what impact that has on currency reserves, specifically the dollar's dominance as the reserve currency, if there is any correlation. I'm a believer in Bitcoin. We've recommended it for our clients for more than eight years because we do think it's an important asset to have exposure to. Our original recommendation was 1%. Today, for newer investors, I would recommend 2 to 5. the u.s government is itself is talking about making bitcoin a strategic reserve asset and i know there's some pushback for a couple reasons one is um you know bitcoin uh is harder and less tangible relative to a hard asset like gold in the u.s holdings of gold is actually around 660 billion dollars today it's actually carried on the balance sheet at 1971 cost.

44:05So it's carried at 11 billion, but the U S has$660 billion worth of gold. Bitcoin is trading at 10 % of the network asset value of gold today. So it's a$2 trillion asset versus gold at 20 trillion. So I would say if the U S was just trying to diversify its, you know, currency holdings, you know, they should own 60 billion incrementally of Bitcoin at least. but i think it's a very interesting question because i've heard a lot of people weigh in that if the u.s starts to uh own bitcoin as a reserve asset that it would affect dollar dominance the one thing i would just point out is that in the digital assets world when we look at crypto pricing the dollar is by country mile um a bigger reserve asset all almost all the stable coins i I would say if you look at stablecoin dominance, it's 90 % dollar.

44:59So in a digital native world, the dollar is more important than the euro, the reninbi, than the yen, the one. The only currency people really quote crypto assets in is USD. So I think if that's a proxy, dollar dominance would actually be bigger in a future Bitcoin world. What are your thoughts on how AI impacts, one, AI stocks or AI-related stocks, and two, which sectors do you think are poised to benefit the most or get hurt the most as AI kind of seeps, if you will, into the regular economy? In simplistic terms, over time, as AI becomes both physically automated and then generative and PhD level, I think it really risks replacing the benefit of human labor.

45:50And there's many books, including The Coming Wave, that really talk about the risks of AI that's unbounded. And one thing I am just supposing that even in a world of like, let's say financial markets, if it was dominated by AI, in a world where more decisions are made by AI than humans, I think that you're going to end up with a lot of cheating and a lot of spoofing. Because that deception is a very high return on investment activity versus being smart and identifying inflection before anyone else does. And so I think unless there is, I would call, ethical bounds on AI, I think that it'll be easier to rob a bank than to try to make money and to earn capital.

46:40So I'm being extreme. So I think that over the next few years, I'm not sure whether or not it's going to ultimately be good for markets. However, if I look at where companies could actually leverage AI the most, I think it's going to be in cases where you don't have productive output by employees. And I think that one easy measure is look at market value of a stock divided by the number of employees because it's a measure of how human intensive a company is. So if you took the MAG-7, the market value per employee is like over$20 million. So those companies already have enormous productivity for each worker because it's either software, technology, or network effects driving the business.

47:31But if you take restaurants, many of them trade at$25 ,000 per employee. Well, I'd love some examples. Use the word spoof. Do you just think that AI will make criminal activity lower the bar in terms of people's ability to enter and profit from criminality or that there'll be specific market, exogenous market risks around spoofing, insider trading, market manipulation? Say more about your fears around AI as it relates to criminal activity. Yeah. And Scott, I guess what I would, like if I were to re, not use the word criminal activity, but what I call non-ethical activity, for instance, as a competitive tool, if AI, if someone said program, okay, program AI so that my product is something other customers want, that AI system might decide that it has to make two decisions.

48:25I can either try to convince people that this is the best product that's out there and it does so many magical things, but then you have to prove all these things. Or maybe it'll decide, I'll just badmouth every other competitor, write fake reviews, bad reviews, claim there's recalls, file complaints. And so that can be done at scale using AI agents. And I'm not saying I know this is going to happen. and I'm just sort of observing that it'll probably be easier for a strategy to employ AI is to undermine competitors. And in the financial markets, AI systems might realize, oh, it'll be easier to spoof a CFO into revealing financial results because they think they were getting an email from their auditor, send the numbers, and so now I know what the company's going to report.

49:19or it'll be easier to make a malicious agent that spies on everybody's computer and then they know what the activity of the company is. So that's how I get ahead instead of trying to use alternative data to figure out what's really happening in a business. I guess I'm just saying that integrity of data and cybersecurity are going to be very important because in the future, I think AI agents might conclude it's easier to cheat. I just find that such an interesting and true observation that it's like AI could be so creative in so many ways, and one of the ways it could be creative is in screwing other people over.

49:55I mean, humans are pretty good at screwing people in various ways, but I would bet that an AI would be even better at it. Yeah, and I remember something that Robert Gilles, the head of Coca-Cola once said, because when I was an undergraduate at Wharton, he came in and spoke to our marketing class, And he said that when a customer has a good experience, they only tell one person. When a customer has a bad experience, they tell 10 people. So if that's actually the pattern of us, then I would think an AI agent would realize it's easier to spread bad stories about a competitor than to try to make people believe your product is great.

50:34Yeah, I hadn't thought of that. I absolutely agree. Oh, sorry, Scott. And this is your domain. So obviously, you know marketing way better than me. So I'm sorry if I... Quickly kiss the ring. Yeah. Yes. I just want to move through more of these topics in this 2025 outlook. You mentioned that you think that DOGE, the Department of Government Efficiency, could be too effective, which I thought was an interesting phrasing. What do you mean by too effective and how do you see that playing out? When we talk to policymakers and we hear it from policymakers, the biggest threat to the U.S. dominance and really the U.S.

51:16economy is the growing U.S. deficit. And we're on an unsustainable path. And I think almost everybody in markets agrees. And the numbers are staggering. And there is now a very ambitious effort to try to formulate some sort of plan to contain either the growth of government spending or even cut government spending, which is doge. And it's led by Elon Musk and Vivek Ramaswani. This, to me, harkens back to several chapters of the Truman biography I read by David McCullough, which talks about Truman's work during World War II. And I don't know if it's as widely appreciated, but he formed a committee called the Truman Committee.

52:04And the reason it was formed was that during the early days of World War II, the U.S. government couldn't afford to spend on military spending to fund World War II, which was to support the Allies. and so the U.S. was borrowing a lot of money. But what the U.S. also found was that the companies supplying the U.S. were actually either providing inferior parts, overcharging. The Truman Committee was formed, no executive powers. Truman brought in seven senators, and the only real tool they had was public radio, where they could embarrass companies using the public airwaves. And as a result of the Truman Committee, the U.S.

52:49saved as much as$15 billion. There were numerous examples that the Truman Committee found, whether it was defective engine parts leading to planes crashing, overcharging for steel. And he is widely credited for allowing the U.S. to actually fund World War II without going bankrupt. So he was the original doge, and he accomplished all this without any real executive powers, but just a public pulpit. Will Doge be able to achieve the same thing? I don't know. I am concerned that part of this process will be the public airing of examples of government waste, which could be very embarrassing for companies, but it could also become very divisive because it may embarrass companies.

53:36It could anger people. And I don't want to be alarmist, but look at what happened when someone got very angry at health care insurers. You know, unfortunately led to the assassination of a CEO. Could something like this happen if Doge exposes a lot of government waste? I don't know. So to me, I think it's a very noble undertaking. And I think it hopefully is bipartisan. I don't know how effective it's going to be. But if it's too effective and it leads to a slowdown to government spending, it actually could be contractionary. As far as how I would position investors, those who are large recipients of government payments, to me, are the ones that investors are going to worry about if a large percentage of their revenues are from the federal government.

54:26My concern with the whole Doge thing is that it doesn't feel as much about actually addressing the issue as much as it feels like a sort of metaphorical fuck you to the bureaucratic class in general. Because, you know, so I hope that that's what we can see with this in the next year where we can actually target the actually wasteful spending. but as you know as we've discussed a lot of that is just defense and social security so we'll be very interesting to see how that plays out we should wrap up here scott do you have any last questions and i'll i do i've got one more yeah yeah so tom you advise some of the biggest institutional investors in the world i want you to go down market a lot of the types of questions we get are along the following lines 30 year old married we've managed to scrape together a hundred thousand dollars and we really don't know what to do with it.

55:19And the market seems expensive. We don't want to be the ones that got in at the top. You're advising your, you know, your nephew or a friend who's doing well, saving some money and just starting to invest. How, what would your asset allocation recommendation be for a young couple with a little bit of money that wants to start investing right now? I think one of the key words that you said, Scott, was young. I think when someone's young, they have time on their side. A young person, let's say someone in their 30s, has 60 years on their investment horizon. And that is a huge, huge advantage because most people who invest only think one month ahead or even one day ahead.

56:08So there's a couple things I'd offer advice as. Number one is over the long term, the ups and downs of the market matter less because everything that has growth grows in value. So I think equity should always be a big part of someone's allocation, but that also should include real estate because land has a good history. And of course, owning Bitcoin or gold or both. The second thing I would just note is the importance of dollar cost averaging. I think many people feel anxious at the top that they have to put all their chips into the market. They don't. They should have a program to invest steadily.

56:52And so we always advise dollar cost averaging. So whether that means you make a commitment to buy every month or you buy every time there's a dip, I'd really recommend people dollar cost average. And the third piece of advice I'd give people is that they need to be really patient. And as much as someone thinks buying at the top is dangerous, J.P. Morgan's private bank has a very famous chart that shows if you bought the S &P only at all-time highs, you actually had better returns than dollar-cost averaging in general, meaning it's actually okay to buy at all-time highs because you know you're in a bull market.

57:39Of course, there'll be one day when you actually bought, and it literally is the high. But if you have 20 years, you never had a negative rolling 10-year period. So as long as you own something for 10 years, you don't have to worry about buying at the highs. I love that. I feel like my fear of buying at all-time highs, it's mainly a fear of being stupid. But maybe being fearful of stupid is in itself stupid. We've talked a lot about 2025 and what you think is going to happen in the year ahead. I'd just like to end here with a reflection on 2024. Is there anything that happened this year, Tom, that has fundamentally changed your view of the world?

58:24And it could be in markets or in politics. It could be in anything. but something that really changed your perspective and that you are carrying with you into 2025? I'm probably going to limit it more to my perceptions of markets. But I think 2024 is a year that really has proven that companies have been battle-tested. We first had a pandemic that shut the global economy down in 2020, and very few companies went bankrupt. And then in 2021, we had an inflation surge that historically would catch many businesses by surprise. But businesses saw this happening and they endured it. And then in 2022, the Fed embarked on the fastest tightening cycle in history to put a heart attack on the economy.

59:19And very few businesses failed. So we've put corporate America through three stress tests that you normally might see one of these in 50 years. We saw three of three things happen in three consecutive years. And businesses are doing well. So I think in general, there's a reason the S &P has done as well as it has, because it's proven to be an exceptionally strong index made of very, very strong companies. Tom Lee is the co-founder, managing partner, and head of research at Fundstrat Global Advisors, a leading independent research firm. He has 25 years of experience in equity research and has been top-ranked by an institutional investor every year since 1998.

1:00:01Prior to co-founding Fundstrat, he served most recently as JP Morgan's chief equity strategist from 2007 to 2014. Tom, this was a pleasure and fascinating. Thank you very much for joining us. Good to see you, Tom. Yeah, thank you. Good to see you, Scott. Thanks, Ed. This episode was produced by Claire Miller and engineered by Benjamin Spencer. Our associate producer is Alison Weiss. Mia Silverio is our research lead. Jessica Lange is our research associate. Drew Burrows is our technical director. And Catherine Dillon is our executive producer. Thank you for listening to Prof G Markets from the Vox Media Podcast Network.

1:00:34If you liked what you heard, give us a follow and join us for a fresh take on markets on Monday.

1:00:42Lifetimes.

1:00:47You have me in kind reunion As the world turns And the dark flies In love, love, love, love