A Tactical Perspective on Emerging Economic and Market Trends
January 7, 2025

At Tactical Investments, we have been closely monitoring the evolving economic and market dynamics. Recent developments in interest rates, the yield curve, and other critical indicators have only strengthened our investment outlook. Market conditions continue to align with our thesis: that an overdue recession and market correction are unfolding and will likely play out in earnest in 2025. Below are key developments shaping this outlook:

Interest Rates, Yield Curve, and Economic Signals

The U.S. Treasury yield curve has undergone a significant transition. For months, the spread between the 3-month and 10-year Treasury yields remained deeply negative—a classic inversion and one of the most reliable recession indicators. Recently, this spread has begun to uninvert, with long-term rates rising as short-term rates remain elevated. This development often signals the onset of a recession or that the economy is already in one.

The Federal Reserve has implemented rate cuts totaling 100 basis points in recent months. However, as we anticipated, the Fed has tempered its projections for additional cuts in 2025 due to persistent “sticky inflation.” Inflation in core goods and services remains stubbornly high, driven by structural factors such as labor market tightness and supply chain complexities. As a result, the Fed has adjusted its policy stance. Long-term rates have risen, with the 10-year Treasury yield now at 4.52% and the 30-year yield at 4.72%. These developments underscore the difficulty of controlling inflation in an environment of entrenched price increases.

Rising long-term yields and sticky inflation create significant headwinds for equity markets. Valuation pressures intensify as discount rates increase, while higher borrowing costs impact corporate profitability and consumer spending. This environment sets the stage for the market correction we have anticipated.

Broader Market and Economic Indicators

In addition to yield curve dynamics, other critical data points support our outlook:

Credit Market Stress
The delinquency rate for office-backed CMBS loans rose to 11.01% in December 2024, a record high and surpassing the previous peak of 10.7% observed during the aftermath of the 2008 financial crisis. This reflects significant stress in commercial real estate due to changing work patterns and economic headwinds.

Market Sentiment
Over the past 6 to 12 months, we’ve observed more frequent spikes in the VIX, signaling rising market volatility. For example, in December 2024, the VIX spiked by 58% following Federal Reserve Chair Jerome Powell’s hawkish stance, reflecting heightened investor fear and uncertainty. NYSE margin debt has dropped 12% in the past three months, suggesting reduced risk-taking. Additionally, insider selling has increased by 25% in the last quarter, often a signal of waning confidence in future performance.

Economic Weakness
The December PMI fell to 48.7, below the threshold for growth, indicating a contraction in manufacturing activity. Weekly initial jobless claims rose to 280,000 in late December, marking a significant increase from prior months. Over 34% of households report cutting back on basic expenses to manage rising energy bills, underscoring consumer financial stress.

Slowing Housing Market
The U.S. housing market continues to show signs of cooling. Active home listings increased by 12% year-over-year during the four weeks ending December 22, 2024, reflecting a rise in inventory levels. Despite a seasonal slowdown, inventory remains 22% higher than in December 2023. Homes now spend an average of 70 days on the market, the slowest December in five years, highlighting reduced buyer urgency. Elevated mortgage rates and high home prices have created affordability challenges, with the share of first-time homebuyers falling to a historic low of 24% in 2024. These factors suggest broader implications for the economy, including potential impacts on consumer spending and the financial sector.

Stock Market and Valuation Risks
The S&P 500’s current price-to-earnings (P/E) ratio stands at approximately 29.3, significantly above the historical median of 17.9. This elevated valuation mirrors levels observed during previous market peaks, such as the dot-com bubble in the late 1990s, where the P/E ratio exceeded 30. In the lead-up to the 2008 financial crisis, the P/E ratio was around 21.5 in January 2008. For perspective, during the dot-com bubble, the S&P 500 experienced a peak-to-trough decline of approximately 49% from March 2000 to October 2002. Similarly, during the 2008 financial crisis, the S&P 500 saw a peak-to-trough decline of about 57% from October 2007 to March 2009. The S&P 500 recently breached its 200-day moving average, and rally volumes have declined, both of which are bearish signals.

A Tactical Approach: Preparing for Opportunity Amid Volatility

At Tactical Investments, we anticipated these developments and structured our strategies accordingly. The combination of an uninverting 3-month vs. 10-year yield curve, rising credit stress, sticky inflation, a slowing housing market, and an economic slowdown suggests we are entering a meaningful recession. This correction is necessary to address imbalances built up over years of market exuberance, and we believe the coming correction will present unique opportunities for disciplined, long-term investors. Our Balanced Strategy is particularly well-positioned to capitalize on these conditions by:

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• Targeting High-Dividend Stocks: Prioritizing reliable income-generating equities that can deliver returns even in uncertain markets.

• Focusing on Undervalued Opportunities: Identifying companies with strong fundamentals that become attractively priced during market dislocations.

• Maintaining Liquidity for Opportunistic Entry: Ensuring we have the flexibility to act decisively when valuations align with our investment criteria.

 

 

While the coming months may test investor resolve, we remain confident in our approach. These shifts in the market and economy often take longer to fully unfold than expected, even when the data clearly points to an eventual outcome. For those who want to assess their current asset allocation in anticipation of buying opportunities that may soon arise, we would love to hear from you. We are here and ready to discuss our perspective and how you can begin to prepare and position your portfolio based on how things appear to be unfolding.