My Macro Views for the Start of 2025

In the words of Mark Twain, "The two most important days in your life are the day you are born and the day you find out why." 

This is my final write-up of 2024.  I will start with a brief discussion of gold, and then shift to a more general assessment of where the markets are heading.  To a large extent, my analysis of the gold market and my broader macro views are intertwined and connected.  Let’s dive in. 

Several months ago, on October 25, I recommended that my readers take profits on at least a portion of their long gold positions.  Gold had rallied all the way to $2790, having climbed over 40% since the middle of February, and I felt that the market was way over-done in the short term and desperately in need of a period of corrective price action.  My longer-term view was bullish, but I was quite sure that the markets needed some time to digest such a large move.

Since that time, gold has traded as low as $2537, and it is currently trading just above $2600. I now feel that gold is nearing the end of its corrective cycle.  I am expecting one more short-lived sell-off towards the mid-$2400’s before it resumes its longer-term bull market.  Even though my long-term view is extremely bullish, I have been running a modest short position in gold, waiting for this corrective pattern to play out.  I will definitely be quick to cover my shorts anywhere close to my target, most likely scaling out of my shorts progressively, with my initial buying around the $2500 level.  Given my big picture view, however, I have trailing stop-loss and buy-entry orders in case gold decides to resume its long-term advance sooner than expected.  In a worst case, I will stop out of my short gold positions with a profit and begin re-establishing my long positions well before gold reaches its recent highs.   

In the big picture, gold should have quite a long way to rally before its longer-term bull cycle is done.  The central banks and treasury departments of the G-8 nations are unwittingly doing everything possible to ensure the long-term strength of gold.  Excessive monetary stimulus coupled with huge fiscal deficits almost guarantees the long-term diminishment of the buying power of fiat currencies.  Gold is a great alternative as a store of value, so it should not come as a surprise to know that central banks have been aggressively buying this precious metal. Consider the following: It took the US 220 years for the nation’s total government debt to reach $11 trillion, but the US has added over $11 trillion in debt since 2020!!  At the current pace, we will hit $50 trillion in total debt before too long, and that will almost guarantee increased demand for gold as people will want to diversify away from fiat currencies in ever-increasing amounts.  Central banks and other strategic investors who have a good handle on the broader macro picture will almost surely continue their gold buying, and perhaps even accelerate the pace of their buying.  

Interest payments alone on US debt in 2025 will exceed the total GDP of Spain.  US fiscal deficits are massive, and they are projected to keep expanding at an astounding pace.  This cannot occur without consequence. The current and projected US deficit levels have no historical precedent as a percentage of GDP, except during major financial crises and wars.  The long-term average annual fiscal deficit for the US during periods of low unemployment – such as what we have had for some years – is less than 2.5%.  Yet we are running astounding deficits in excess of 6%, and most forecasts assume continued annual fiscal deficits of 6.3% for many years to come.  This is not just scary, it is outright terrifying. Moreover, these forecasted deficits assume that we remain recession-free. This is an unsustainable path, and eventually, something has to break – or at least dramatically change.

What might break, and how will it play out?  This is the multi-trillion-dollar question, and it warrants some serious consideration.  One obvious long-term by-product of ever-increasing government deficits will be higher bond yields in the US as the government will eventually struggle to fund its deficits.  Naturally, the Fed will try to keep rates as low as possible to promote economic growth, but as we have seen in recent months, the Fed’s rate-cutting has had an inverse impact on bond yields, which have climbed sharply with each rate cut.  The aggressive anti-BRICS rhetoric coming out of the US is largely focused on the realization that the US needs to maintain its hegemonic status indefinitely, as this ensures enormous demand for US dollar assets since so many goods are primarily priced in dollars.  For the most part, buyers of oil, gold, and other commodities have to hold dollars in order to buy these assets, and this helps the US fund its deficits.

In a broader historical context, the US is not in a unique position.  Over the centuries many great nations have ruined their finances through poor management and ultimately fell from power. The US has not reached this tipping point yet, but its current path is unsustainable.  Strong action must be taken, or else the country’s great power and world leadership will be at risk.  Interestingly, some leading nations with even worse fiscal situations are able to fund their deficits.  Japan, for example, has a debt to GDP level of 255% -- a level that that is roughly twice that of the US – but they very little trouble financing their deficit due to enormous Japanese savings.  Ten-year government bonds in Japan are trading at 1.1% while US 10-year bonds are trading at 4.6%.  The much higher rates in the US make the funding of US debt much more expensive.  

If the U.S. fiscal situation continues to deteriorate, I foresee multiple long-term dangers to the economy:

1. Crowding Out Private Investment: High levels of government debt can lead to higher interest rates, which makes borrowing more expensive for businesses and consumers. This can reduce private investment and slow economic growth.
2. Higher Interest Payments: As debt increases, so do the interest payments on that debt. This can consume a larger portion of the federal budget, leaving less money available for other important programs and investments.
3. Reduced Fiscal Flexibility: With a significant portion of the budget dedicated to servicing debt, the government has less flexibility to respond to economic crises, natural disasters, and other emergencies.
4. Economic Growth Slowdown: High debt levels can lead to slower economic growth, as resources are diverted from productive investments to debt servicing. This can result in lower income growth and higher unemployment rates.
5. Increased Risk of Fiscal Crisis: If investors lose confidence in the government's ability to manage its debt, it could lead to a fiscal crisis. This could force the government to implement sudden and severe austerity measures, which could further damage the economy.
6. Geopolitical Risks: A large portion of U.S. debt is held by foreign governments and investors. This can give other countries leverage over the U.S. and create geopolitical risks.
7. Generational Inequity: Future generations may face higher taxes and reduced public services as they bear the burden of repaying today's debt.  We are already seeing generational inequity in the form of housing unaffordability.  This inequity could eventually expand to cover many other critical areas.  This can, in turn, lead to social unrest, so this inequity should not be taken lightly.

Addressing these issues will require a combination of spending cuts, tax reforms, and policies aimed at promoting economic growth. It's a complex challenge, but one that policymakers will need to tackle to ensure long-term economic and social stability.  There are a host of tangential problems that the US fiscal situation could cause.   Bottom line, if foreign  investors lose trust in U.S. debt, the US will almost certainly experience a horrific financial crisis.  Of course, one radical and particularly controversial outcome might be a sort of de facto default on US debt.  This would have been totally unthinkable twenty-five years ago, when the US was last running a fiscal surplus, but it is quite thinkable now.  

I wouldn’t expect it to be a blanket default.  Rather, I would expect a staggered default in which the US government commits to repay the outstanding principal amount of the debt, but otherwise refuses to pay the associated coupons of the debt.  Accordingly, this is one reason that long-term investors should seriously consider focusing on zero-coupon debt with the implied interest rates priced into the cost of the debt.  The authorities would likely want to call this a restructuring of debt rather than a default, but the awful reality would be the same.

There are a host of tangential problems which a true fiscal crisis would create.  Some of the obvious ones include the following:

1. Rising Interest Rates: To attract investors, the U.S. government would need to offer higher interest rates on its bonds. This would increase borrowing costs for the government, businesses, and consumers, slowing down economic growth.
2. Currency Devaluation: Loss of confidence in U.S. debt would lead to a devaluation of the U.S. dollar, making imports more expensive and potentially leading to inflation.  This would also further exacerbate the loss of confidence in US assets, creating a vicious, spiraling collapse in US assets.  The dollar would crash, reaching levels that were once considered to be unthinkable.
3. Stock Market Turmoil: The financial markets would experience significant volatility, with stock prices falling sharply as investors seek safer assets.  It is in this context that I can easily envision a massive equity market crash with higher bond yields and gold prices soaring.
4. Global Economic Impact: Given the interconnectedness of global financial markets, a crisis in the U.S. could have ripple effects worldwide, causing economic instability in other countries.  When the US sneezes, the rest of the world catches the flu.  When the US goes into crisis-mode, the rest of the world will have a seizure.
5. Reduced Investor Confidence: A loss of trust in U.S. debt could lead to a broader loss of confidence in the U.S. economy, affecting everything from foreign direct investment to international trade.  Again, this would lead to an ugly spiraling effect.  

Yes, this is an ugly picture, and although it is avoidable, it is becoming increasingly likely over the next ten-to-fifteen years.  Historically, the US has gone isolationist during times of severe crisis, and that is certainly a realistic possibility. The US can also lend a helping hand to other nations.   The US overall has a dynamic, robust economy which can typically function quite well on its own.  The problem has been due to the leadership in Washington, not because of the lack of creativity and tremendous effort in the workplace.

There will almost certainly be a high level of tension over the coming years between those forces in the US that want the US to go isolationist and those that want the US to help cushion the blows of a global financial crisis.  In the past 100 years, we have seen the US take extreme stances on both sides of the spectrum.  In the 1930’s, during the height of the depression, the US went completely isolationist.  Then, after World War II, the US completely opened up its economy to help its war-time enemies recover.

At the end of World War II, the US economy accounted for more than 40% of the global GDP.  In the aftermath of World War II, the US opened its markets and offered extremely favorable foreign exchange rates and trade incentives to Germany and Japan in order to help them recover from the war and rebuild their tattered economies. These “favorable” exchange rates were set at ludicrous levels that were grotesquely skewed in favor of Germany and Japan, but that was absolutely intentional.  The logic was simple – give these nations unfair trade advantages to help their war-torn economies heal while simultaneously establish strong bilateral trade relationships in order to hopefully avert future wars.  The US reasoned that Germany and Japan would be less likely to have another war with the US if they were engaged in active international trading with the US.  So far, this logic has proven to be sound. Of course, it has been a major battle for the US to claw back some of the unfair trade advantages that it had granted its former enemies, but that is hardly surprising.  Why would Japan and Germany, and others, want to give back trade advantages once they became accustomed to them?

In the current context, we can see similar silly trade policies with nations such as China, which is still operating under the aegis of a “developing nation.”  China was granted the status of a developing nation by international organizations such as the World Trade Organization (WTO) and the United Nations (UN) in the early 1990s. This classification allows China to receive special benefits, such as longer timeframes to meet trade obligations and access to low-interest loans.  Despite its economic growth and status as the world's second-largest economy, China still maintains this developing nation status.  

The logic used by China to maintain this status includes some of the following arguments, which frankly, I find wholly unjustified.

1. Income Disparities: China has significant income disparities, with a large portion of its population still living below the poverty line. This is one of the criteria used by organizations to determine developing status.
2. Economic Development: China argues that, despite its economic progress, it still faces challenges typical of developing nations, such as regional income inequality and the need for continued economic development.

It is clear that the US is intent on leveling the playing field with China, whether it be via tariffs or perhaps other trade restrictions.  The US is also very determined to maintain its global hegemonic status.  Accordingly, the US and China will have increasing trade tensions over the coming years as China steadfastly refuses to compete on a level playing field.  Therefore, the US will have no alternative except to force the playing field to be a bit more level via hefty tariffs.  Will this strategy be effective?  I think that over time it will be effective, although there will almost surely be a great deal of bitter rhetoric as a precursor to a negotiated settlement between these two nations. There will also be some undesirable collateral damage in the US in the form of higher prices as well as  some unpleasant collateral damage for countries such as Mexico, through which China tries to secretly channel some of its exports into the US.  We could also see severe repercussions in China as we are already seeing cracks in the Chinese economy due to extreme overdevelopment in the real estate sector, and a de facto trade war could easily push China into an economic crisis.

Against this rather ugly backdrop, the US equity markets have largely continued to defy gravity – and ignore sound fundamental analysis.  The stock market has been largely carried on the back of the eight largest companies, which account for more than 35% of the total S&P500 market capitalization.  This concerted concentration is dramatically higher than the prior high of roughly 22% in 1999, which preceded by just a few months the implosion of the Dot-com bubble.  Starting in January 2000, in just thirty months, the S&P500 dropped from 1552 to 768, losing almost exactly 50% of its value. 

The heaviest market concentration at that time was actually in the Nasdaq, which dropped even more dramatically during the same period, experiencing a loss in value of roughly 84%.  Am I specifically forecasting this sort of collapse in value?  Not exactly, although I believe this sort of enormous correction has an increasingly high likelihood.  I certainly believe that we can have a 50% to 60% drop in the equity markets as the extreme current levels of bullishness in the market are typically a perfect counter-indicator as a forecast. 

The situation with US equities is particularly important right now.  The markets are priced at ridiculously overvalued levels, although that doesn’t mean that they can’t become even more overvalued.  There are many things which could trigger a major correction, but I am personally hoping that we get one more sharp rally before the decline begins in earnest.  In a perfect scenario, I would like to see a further short-term drop in the stock market of a few percent, followed by a final rally to new all-time highs – or at least close to them.  That rally would probably suck in everyone who had stayed on the sidelines and increase the probability of an absolute rout in the market.  This correction will be an enormous trading opportunity, but I don’t think it is quite yet time for this to take place.

I have never seen such a plethora of bullish forecasts by Wall Street’s supposedly best and brightest analysts.  The least bullish analysts are calling for at least a 10% rally in stocks in 2025, while quite a few are forecasting rallies of 15% or more.  At the same time, we have by number of objective measures confirming that we currently have one of the most overvalued equity markets ever, if not the most overvalued.  Consider the following measures, which are just a few of many indicators all pointing to the same conclusion that we must be very careful!!

1. Buffett Indicator: This indicator, which compares the total market value of all publicly traded stocks to GDP, currently stands at 208%. This is significantly above the historical average, suggesting the market is strongly overvalued.
2. Shiller CAPE Ratio: The Cyclically Adjusted Price-to-Earnings (CAPE) ratio for the S&P 500 is currently 35.23, which is well above the long-term average of around 30. This high CAPE ratio suggests that future returns may be lower than historical averages.
3. P/E Ratio: The S&P 500's 10-year Price-to-Earnings ratio is 36.5, which is also significantly higher than the modern-era market average of 20.4. This indicates an extreme overvaluation.

These indicators, among many others, collectively suggest that the stock market is currently overvalued.  There are many other factors which also make me very nervous about equities over the medium term.  Some of these issues relate to equity valuation, while some relate to specific aspects of vulnerability in the economy.  For example, we are likely to see further dramatic downward revisions of job growth in the US, which raises serious questions about the true strength of the US economy. At the same time, we see conditions in the housing market defy the sharp rise in interest rates by remaining very tight, with prices staying high, while simultaneously we see exceptional weakness in commercial real estate.  Bottom line, I see lots of conflicting signals.  It is not clear how all of this plays out.

On a more cynical note, I want to congratulate Bank of America analysts, who have offered a masterful mix of pessimistic analysis coupled with a bullish forecast that almost guarantees that part of their forecast will be spot on.  On the one hand, they believe that the market is dramatically overvalued by 19 out of 20 different measures.  On the other hand, they nevertheless offer a forecast for 2025 that calls for an 11% rally in the market.  It is really one of my favorite forecasts ever.  These analysts noted, “Although equity sentiment and valuation are currently elevated, we still see ample reason to stick with stocks over bonds for the long-term.”  This was almost a perfect hedge.  

So how am I preparing for a potential sharp decline in equities that is likely to begin over the next year?  I have slowly increased my long yen exposure on the crosses as I believe that in the event of a true financial crisis, the yen will reign supreme.  The yen is very oversold on almost every timeframe, so this should be a relatively safe and inexpensive way to hedge against very sharp and sudden declines in the equity markets.  Historically, a long yen exposure has been an excellent risk-off hedge, and I expect it to continue to fulfill this role.  Plus, it can still make some money in a risk-on environment.  This is much more efficient than buying dramatically overvalued puts on stock indices.  (In some cases, the out-of-the-money puts trade at volatility levels that are more than three times as high as the at-the-money puts.)

Additionally, I am running some modest short positions in certain transportation-related and tech stocks through simple, limited-risk option strategies.  One stock in particular that has very interesting downside potential is Micron Technology.  It is sitting on key support around $85 a share, but if it breaks this support, we could very quickly see a very sharp decline to much lower levels.  

I am also interested in building up a larger short in Tesla shares.  I have felt for some time that it will be hard for Tesla stock to have much more good news than what we have already seen.  The CEO is arguably one of the most powerful people in the world now, and this power will be largely unabated for some time.  At the same time, I find it hard to imagine what sorts of positive news might come out in the near future that isn’t already priced into the stock.  How big a decline am I foreseeing?  This is a tough one, as I can easily make a call for at least another $40 decline, but potentially a decline of as much as $170 from current levels.  I am taking this trade one step at a time.  

As a final thought process, I want you to consider a somewhat radical possible solution to the US fiscal debt bomb.  Imagine what the likely long-term impact on the US economy might be if the US opened its borders and welcomed 300 million people to come and take residence. I have been thinking about this lately, and I believe it might be the very best way for the US to grow its way out of its debt problem.  Sure, there are many problems with this idea, but the upside is intriguing.  Here are some of the very mixed effects if the U.S. suddenly had an extra 300 million residents to integrate into its society.  For sure, it would have profound effects on the economy, but I think that if it were planned properly, it could actually be a fantastic solution for the US economy over the long term.  

1. Labor Market: The influx of new residents would significantly increase the labor force. However, it could also result in increased competition for jobs, potentially driving down wages, especially for low-skilled positions.
2. Housing Demand: With more people needing homes, there would be a dramatic surge in demand for housing. This could drive up real estate prices and rents, making housing less affordable for many.  At the same time, however, this could also be an absolute boon for the construction of apartment buildings, single-family homes, and multi-family homes.  There would be almost staggering demand for supplies, services, and related labor, and overall, the economy would benefit enormously from this.
3. Infrastructure Strain: Existing infrastructure, such as roads, public transportation, schools, and hospitals, would face increased pressure. This could lead to congestion, longer commute times, and overburdened public services.  It would also lead to a wide array of much-needed infrastructural upgrades and reforms.  Again, depending on how this is handled, it could be a mixed blessing.
4. Food and Energy: There would be an enormous increase in the demand for food and energy.  This would create both challenges and opportunities for the expansion of existing supplies and the development of new ones.
5. Economic Growth: The increased population could boost economic growth by expanding the consumer base and creating more demand for goods and services. However, this growth would need to be managed carefully to avoid overheating the economy.
6. Government Spending: The government would need to invest heavily in infrastructure, education, healthcare, and other public services to accommodate the growing population. This could lead to higher taxes or increased public debt, but the economy might surge, thereby making the debt a smaller percentage of the GDP.
7. Environmental Impact: A larger population would put additional pressure on natural resources and the environment. Issues such as pollution, waste management, and water supply would become more critical.
8. Social Services: There would be a greater need for social services, including healthcare, education, law enforcement, and welfare programs. Ensuring these services are adequately funded and accessible would be a significant challenge.

Overall, an increase in population could bring massive economic opportunities, although it would also require careful planning and significant investment to manage the associated challenges effectively.  While there are currently some strong barriers to foreign immigration into the US, with a bit of luck, such a development might prove to be the best way for the US to effectively grow its way out of its current fiscal debt bomb.  I need to refine my thinking about this topic, but it just might turn out to be the very best way to ensure the long-term strength and stability of the US economy.  It might also prove to be the most politically divisive idea, but that is a different discussion for a different day.  

In the meantime, I wish you all the best of luck with your trading.  I also want to wish all of you a wonderful 2025.  May it prove to be your best year yet.