Equity Markets
The S&P 500 returned 25% over the course of 2024, its third 20% plus annual return in the last four years, but growing macroeconomic uncertainty resulted in the index dipping to 2.4% over the last month of the year1. Following a close election, U.S. markets rallied reflecting investor optimism for a more pro-business environment and stronger growth with Republican control of government. However, uncertainty increased as investors contemplated the impact of large policy changes (e.g., tax cuts, tariffs, reduced immigration, etc.) on inflation and U.S. debt levels, along with increasing expectations the Federal Reserve will keep rates higher for longer. Small cap equities had a more dramatic sell off (up 11.5% in 2024, but down 8.3% in December1) as expectations for higher rates implies a tougher road for small cap earnings growth in coming years.
International equities also finished the year up but sold off over the course of the 4th quarter. Developed markets finished 2024 up 3.8%, but sold off 8.1% in 4Q24, and emerging markets finished the year up 7.5% but sold off 8% over 4Q241. The international markets sell off coincided with growing confidence in the results of the election over the quarter. The economic and geopolitical priorities of the new Republican administration have caused investors to question the growth potential of foreign companies. Increased tariffs could slow growth, and less U.S. political support increases geopolitical uncertainty, which remains a sentiment overhang on international equities.
Our 2025 Annual Investment Outlook provides a more detailed look at our expectations for the coming year. U.S. large cap equities remain expensive, S&P valuations sit in the 93rd percentile since 1990 and price to earnings ratio growth accounted for 61% of the S&P’s 2024 return2. For equities to produce positive returns in 2025, we think equities outside of the Magnificent 73 will need to contribute most of the performance, particularly small and mid-cap equities. Rebounding earnings growth expectations, continued economic growth, and stable inflation will be critical to sustain performance in non-Magnificent 7 companies. There is a lack of clear catalysts in international developed and emerging equities, but valuations are significantly cheaper than U.S. equities. Any positive developments could significantly boost international returns in 2025.
US Economy
The Federal Reserve released its updated economic projections following its December meeting. The Fed reiterated confidence in the pace of economic growth and expects slightly higher GDP growth and a lower unemployment rate compared to September projections. However, the Fed also raised inflation expectations for 2025 and 2026 to 2.5% and 2.2% from 2.2% and 2.0%4. Better economic growth and higher inflation coincided with a more conservative estimate for future rate cuts, the Fed now only expects two 0.25% rate cuts in 2025 and another two in 2026, down from four 0.25% in both 2025 and 20264. The bond market is even more pessimistic as it only expects a total of two 0.25% rate cuts through year end 20275.
Current rate levels are consistent with longer-term historical rate levels, and we’ve seen the return of a normal sloped yield curve (longer-term rates higher than short-term rates) for the first time in two years. A normally sloped yield curve is typically an optimistic sign for future economic growth and is an important part of businesses and investors accepting a higher rate environment. In 2025, investors will closely monitor the economy for signs of slower growth or an inflation resurgence. Rate and economic uncertainty will likely dampen sentiment for more economically sensitive areas of the market (i.e., mid-cap, small cap, and debt-sensitive companies).
Fixed Income
The 10-Year Treasury yield surged to 4.68% from 3.79% in the 4th quarter. The increase was primarily driven by concerns over higher inflation prior to and following the November election, and fewer expected rate cuts in 2025 and 2026 following the December Fed meeting. The Bloomberg US Aggregate Bond Index was down 3.1% in the fourth quarter reflecting surging yield expectations (bond prices fall when market yields rise), but the index returned 1.25% over the course of 2024 as now higher interest payments offset the index’s negative price movement1. In a normal rate environment (i.e., not the zero and ultra-low rate environments following the Great Financial Crisis and Covid-19 pandemic), return from interest payments comprises the majority of long-term bond returns. A return to a higher rate environment is an opportunity for investors to lock in higher intermediate term rates. Intermediate bonds provide a stable income stream and provide better portfolio protection during economic recessions.
We are closely monitoring our fixed income positioning and further increases in intermediate or long-term bond yields could merit further increasing allocations to those asset classes. We also are examining economic trends for signs of deterioration as High Yield, Floating Rate, and Private Credit strategies are more vulnerable to economic turbulence. Our allocation to these credit-based strategies is relatively low and we remain positive regarding the near-term outlook.
1 – Morningstar;
2 – “The Fed Is Battling the Bond Market. How to Avoid the Knife Fight.”, Darren Fonda, Barron’s 12/26/2024;
3 – The Magnificent 7 includes AAPL, AMZN, GOOG, GOOGL, META, MSFT, NVDA, and TSLA;
4 – “Summary of Economic Projections”, Federal Reserve Board members and Bank presidents, Federal Reserve https://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20241218.pdf;
5 – “Guide to the Markets”, JP Morgan, 12/31/2024;