As 2024 draws to a close, investors are grappling with a lackluster market performance and seeking insights into the year ahead. Jim Paulsen, former chief investment strategist of The Leuthold Group and author of the Paulsen Perspectives newsletter, offers a contrarian view, warning of a potential economic slowdown in 2025 that could trigger a stock market correction.
Table Content:
Economic Indicators Point to a Potential Slowdown
Despite prevailing concerns about economic overheating, Paulsen believes an unexpected slowdown is more likely. He cites several indicators to support his claim. The Citi Economic Surprise Index, which tracks the difference between actual economic data and expectations, shows a potential decline. Historically, movements in bond yields have preceded changes in economic surprises. With 10-year Treasury yields hovering near 4.6%, Paulsen suggests the Economic Surprise Index could fall to -35 in the first quarter of 2025, leading to slower GDP growth.
Paulsen acknowledges the resilience of the business and household sectors, making a recession unlikely in the near term. However, he warns that a decline in real GDP growth from the current 2.7% to 2% or less could fuel recessionary fears, negatively impacting profit forecasts and stock valuations.
Financial Conditions and Market Breadth Raise Concerns
The U.S. Financial Conditions Index, a measure of financial stress, has been deteriorating since early December. Paulsen notes that previous declines in this index coincided with significant stock market pullbacks in October 2023 and the summer slump of the “Magnificent 7” tech stocks. While the current decline is less pronounced, he suggests further worsening is possible as economic growth slows.
Furthermore, Paulsen points to deteriorating market breadth, with fewer stocks advancing relative to those declining. This trend, coupled with the underperformance of cyclical and aggressive stocks since mid-November, indicates growing investor caution.
Potential for a Stock Market Correction
Paulsen cautions that a significant economic slowdown, coming as a surprise to many, could trigger a stock market correction of 10% to 15%. He advises investors to remain invested, as the bull market is likely to continue in 2025, albeit with potential bumps along the way. However, he suggests a slight shift towards more defensive investments might be prudent.
The Role of Technology Stocks
The performance of the technology sector will be crucial in determining the depth of any potential correction, according to Paulsen. He highlights the strong correlation between the relative performance of the S&P 500 tech sector and the U.S. Financial Conditions Index over the past four years. A worsening of financial conditions has historically led to tech underperformance, impacting the broader market. Therefore, the key question for 2025 is how much financial conditions will deteriorate and how significantly this will affect technology stocks.
Conclusion
Jim Paulsen’s analysis presents a cautionary perspective on the economic and market outlook for 2025. While he doesn’t foresee a recession, he warns of a potential slowdown that could lead to a stock market correction. He advises investors to remain invested but consider adopting a more defensive stance, particularly regarding technology sector exposure. The interplay between economic growth, financial conditions, and technology stock performance will be critical to watch in the coming year.
