John Kenneth Galbraith, a 20th-century economist, once opined, "The only function of economic forecasting is to make astrology look respectable."
John Templeton pointed out after he sold his funds, "In all my 55 years on Wall Street before I retired to do something vastly more important, I was never able to say when the market would go up or down. Nor was I able to find anybody on Earth whose opinion I would value on the subject of when it would go up and down."
Generally speaking, I agree.
Most economists and market forecasters sit inside the beltway or between the Hudson and East Rivers and study models and get lost in the reams of data from government and other sources on economic activity level. They rarely leave their safe place. Most of their forecasts will be confidently delivered, well documented, and wrong.
If I focus on finding cheap bank stocks with a large margin of safety, time, value, and the need for scale should provide ample returns regardless of what happens on Wall Street or K Street.
In all of Wall Street and Academia, there are three economists to whom I pay attention.
Two work for private equity firms. Both Torsten Slock of Apollo and Henry McVey of KKR see the information most economists never. Because their companies own operating businesses, real estate, and lending businesses all over the world, they see things on a cash in, cash out basis that most prognosticators will never see.
Slock, the Chief Economist of Apollo, has been far more accurate than just about anyone this past year.
I have followed Nancy Lazar, currently the Chief Economist at Piper Sandler, for a long time. She and her team do an incredible job of crunching the numbers and providing useful information and guidance.
Reading through all of the hundreds of pages of current analysis, I have formed an outlook on the economy, prospects, potential pitfalls, and opportunities we are facing in the year ahead. It is about possibilities, not predictions.
The Economy and Markets in 2025: A Tim Melvin Perspective
As we step into 2025, the economic landscape is amid a critical handoff from government driven growth to private sector led dynamism. The transition will not be seamless, but for disciplined, contrarian investors, it is brimming with opportunities. Let us break down the key drivers shaping the economy and markets this year, pulling insights from Apollo Global Management, KKR, and Piper Sandler.
Economic Growth: Slow but Steady
The consensus across all three reports is clear: the United States economy is resilient, but growth is moderating. Apollo's outlook pins GDP growth at 2.3 percent for the year, while KKR projects a slightly lower 2.0 percent, emphasizing the impact of slower government spending and tighter credit markets. Meanwhile, Piper Sandler underscores the balancing act, highlighting that the private sector, particularly small and mid-sized businesses, is filling the void left by shrinking federal outlays.
This transition is not just about numbers, it is about structure. KKR's research emphasizes how deregulation and investment incentives are setting the stage for a more productive economy. AI driven capital expenditures, a recurring theme in both the Apollo and KKR analyses, are paving the way for long term productivity gains. Data centers and AI infrastructure are buzzing with activity, while non-AI related investments remain tepid.
This creates an opportunity for patient investors to capitalize on undervalued sectors.
Inflation: Persistent but Manageable
Inflation is the villain that refuses to exit the stage. Both Apollo and Piper Sandler highlight sticky core inflation, particularly in shelter and services. KKR takes a slightly optimistic view, suggesting that productivity gains from AI adoption could temper inflationary pressures over time. Still, 2025's core CPI is forecast to hover around 2.5 percent, with goods deflation offset by stubborn service inflation.
The Federal Reserve's cautious approach is a key takeaway from all three reports. Rate cuts will come, but they will be gradual. Apollo suggests that the Fed's measured approach will keep long term yields in the 4.25 percent to 4.5 percent range. For yield hungry investors, this environment offers a golden window to lock in higher returns in fixed income.
The Tale of Two Markets: Big versus Small
2024 was the year of bifurcation, as Apollo rightly points out. Large corporations thrived, leveraging fixed rate debt and federal spending to weather the storm of rate hikes. Meanwhile, SMIDs, the workhorses of the economy, bore the brunt of tighter credit and higher borrowing costs.
But 2025 brings hope. KKR's research notes a resurgence in small business optimism, driven by easing lending standards and deregulation. Piper Sandler adds that SMIDs, which account for the majority of job creation, are poised for a gradual recovery as short rates decline. This shift could narrow the gap between large and small firms, creating opportunities for investors willing to dig into overlooked corners of the market.
Consumer Spending: Resilient but Fragile
The consumer remains a pillar of the economy, but the foundation is not as solid as it once was. Apollo highlights robust discretionary spending, buoyed by strong household balance sheets and a wealth effect from rising asset prices. KKR, however, warns that high interest rates and lingering inflation could temper spending growth, especially in the second half of the year. Tariff concerns under the Trump administration are already pulling forward demand, a dynamic Piper Sandler expects will weaken consumer spending later in the year.
Still, all three reports agree that the high-income consumer, those benefiting most from economic bifurcation, will keep spending robust. This creates opportunities in sectors catering to affluent consumers while leaving lower end discretionary spending more vulnerable.
Capital Markets: Stock Pickers' Paradise
Equities are not the slam dunk they have been in prior years. Apollo cautions against lofty valuations, suggesting that earnings growth, not multiple expansion, will drive returns in 2025. The S&P 500 is expected to see modest gains, but KKR's report emphasizes the importance of sectoral rotation. Energy, industrials, and technology tied to AI infrastructure are standout sectors, while overvalued segments of the tech market might face headwinds.
Fixed income, meanwhile, offers a compelling case. Apollo and Piper Sandler both highlight tight spreads and elevated yields, particularly in private credit markets. KKR sees a wealth of opportunities in asset-based finance and middle market direct lending, areas where disciplined investors can extract outsized returns.
Risks: Plenty to Keep You Up at Night
No forecast is complete without a dose of caution. Geopolitical tensions, from Ukraine to Taiwan, loom large, as Apollo and Piper Sandler emphasize. KKR flags the risk of policy missteps, such as aggressive tariff hikes or immigration restrictions, which could disrupt labor markets and supply chains.
The federal deficit is another elephant in the room. At nearly $2 trillion, it is a long term drag on economic growth. Apollo points out that rising interest payments now exceed defense spending, a sobering statistic. While KKR sees potential for deficit reduction through increased tax receipts and fiscal restraint, the risks remain significant.
The Road Ahead: Contrarian Plays for 2025
As always, the real opportunities lie in swimming against the tide. AI driven productivity growth, while hyped, is a long-term game worth playing. Look for undervalued small caps poised to benefit from easing credit conditions and a more favorable regulatory environment. Fixed income, particularly in private credit, offers a chance to lock in high yields before the market shifts.
In housing, affordability challenges are suppressing supply, but that is where contrarian plays emerge. Apollo notes that new construction, particularly in multi-family units, could benefit from loosening lending standards. Investors with a nose for value should pay attention.
Final Thoughts
The economy and markets in 2025 are a story of transition. It is not the roaring bull market of the past decade, but it is not a doom and gloom scenario either. As KKR aptly notes, this environment rewards thoughtful capital allocation and patience. The opportunities are there, you just need to be willing to look where others are not.
Stay contrarian, stay patient, and keep digging. This market is not for the faint of heart, but for those who do the work, 2025 could be a year of significant rewards.
A Final Thought: Buy small banks below book with a margin of safety. Use volatility to build positions. Be patient.