Market Correction Looms: Why This Strategist Expects a 15% Downturn in Early 2025

Market correction on the horizon?
As we approach the new year, investors are bracing for a potential market correction, with one prominent strategist predicting a 15% downturn in early 2025. Mark Matthews of Bank Julius Baer & Co. has cited several reasons for his bearish outlook, including high valuations, narrow market breadth, and inflation risks. Let's delve into the factors driving this prediction and explore the potential catalysts or triggers that could exacerbate or mitigate the expected market correction.

High valuations and narrow market breadth
Mark Matthews has warned that the market is expensive, with valuations only seen twice before in history - during the dot-com bubble and the pandemic stimulus bubble. He stated, "The market is expensive. It has only been this expensive twice before—the dot-com bubble and the pandemic stimulus bubble." Additionally, weak market breadth, with less than 40% of S&P 500 companies trading above their 50-day moving averages, is another sign of vulnerability. Matthews highlights this as a red flag, saying, "Weak market breadth, with less than 40% of S&P 500 companies trading above their 50-day moving averages, is another sign of vulnerability."

Inflation risks and Federal Reserve concerns
The Federal Reserve's (Fed) concerns about inflation are a significant risk factor for Matthews. He notes that the number of Fed officials seeing upside risk to inflation jumped from three in September to 15 out of 19, indicating a significant shift in their outlook. If inflation remains persistent, the Fed could pause rate cuts or even tighten policy, further pressuring markets. Matthews commented, "In the latest summary of economic projections, the number of Fed officials who saw upside risk to inflation jumped from three in September to 15 out of 19. That’s a significant shift."

Potential recession risks and trade policies
Despite the US economy's resilience, Matthews cautions against underestimating the unpredictability of recessions. He mentions that even pro-growth presidents have faced recessions during their terms, suggesting that a recession could still occur under Trump's administration. Furthermore, Trump's trade policies, including tariff threats, could introduce additional uncertainties for global markets. Matthews comments on the ripple effects of a US correction, stating, "In a major US market fall exceeding 20%, it’s hard to see India or other markets holding up. If the US goes into a bear market, I can't recall any previous instances where India didn't go down as well."

Potential catalysts or triggers for the market correction
Several factors could exacerbate or mitigate the expected market correction in 2025. Matthews highlights the following factors:

1. Inflation risks: Persistent inflation could lead the Fed to pause rate cuts or tighten policy, further pressuring markets.
2. Trade policies: Trump's return as president could introduce additional uncertainties for global markets through his trade policies, including tariff threats.
3. Market breadth: Weak market breadth could exacerbate a broad-based market correction.
4. Economic slowdown: If the US economy faces a slowdown or recession, it could mitigate the market correction, as investors may seek safer assets.
5. Policy responses: The Fed's policy response to economic developments could either exacerbate or mitigate the market correction.

In conclusion, Mark Matthews' expectation of a 15% market correction in early 2025 is supported by historical patterns and market cycles, as high valuations, narrow market breadth, inflation risks, and recession risks have all been associated with market corrections in the past. Investors should closely monitor economic indicators, geopolitical developments, and policy responses to assess the potential impact on the market correction in 2025.