2024 U.S. Equity Market Recap and 2025 Outlook
U.S. Equity Market Performance in 2024: A Recap
2024 was marked by resilience in the U.S. economy and strong performance in the stock market despite continued geopolitical tensions, policy uncertainties, and fluctuating inflation. Real Gross Domestic Product (GDP) grew at a solid 3.1% annualized rate in the third quarter, underpinned by robust consumer spending, which benefited from rising household wealth and steady real wage gains.
What is GDP?
In simple terms, GDP shows the economic output of a country, but it removes the effects of price changes over time. This way, we can see the true growth of the economy without being misled by rising prices.
Inflation and the Federal Reserve
Inflation moderated over the year, with headline CPI declining from 3.3% to 2.7% by November, allowing the Federal Reserve to initiate a long-awaited easing cycle with 100 basis points of rate cuts. However, the pace of disinflation slowed in the latter part of the year, highlighting persistent price pressures in sectors like shelter and auto insurance.
What is Inflation?
Inflation is when the prices of goods and services go up over time. Imagine you could buy a candy bar for $1 last year, but this year the same candy bar costs $1.10. That 10-cent increase is due to inflation. In simple terms, inflation means your money doesn't stretch as far as it used to, so you need more money to buy the same things. It's like a slow rise in the cost of living.
Why Does Lower Inflation Allow the Federal Reserve to Cut Rates?
When inflation is low, it means prices aren't rising very quickly. This gives the Federal Reserve (the Fed) more room to lower interest rates. Lower interest rates make borrowing money cheaper for people and businesses. When borrowing is cheaper, people are more likely to take out loans to buy things like houses and cars, and businesses are more likely to invest in new projects and hire more workers. In short, lower inflation allows the Fed to lower rates to encourage spending and investment, which helps boost the economy.
What is Disinflation?
Disinflation is when prices are still going up, but not as quickly as before. Imagine prices were rising fast, like a car speeding down the highway. Disinflation is like the car slowing down, but still moving forward. Prices are increasing, just at a slower pace. For example, if prices were increasing by 5% per year and then they start increasing by only 3% per year, that's disinflation. It means the inflation rate is decreasing, but prices are still rising, just more slowly.
What Drove the U.S. Stock Market?
The S&P 500 TR Index rose 25% and hit 57 new all-time highs, driven in part by AI advancements and robust earnings from mega-cap technology-related companies, collectively referred to as the “Magnificent Seven” (“Mag 7”). This marks two straight years of returns greater than 25%.
What is the S&P 500?
The S&P 500 is a market index that tracks the performance of the largest publicly traded companies in the United States. It can be thought of as a big list of companies that represent a wide range of industries and gives a good overall picture of the U.S. stock market's health.
What is the Magnificent 7?
The Magnificent 7 is a group of leading companies that are technology-related but not all in the Information Technology (IT) sector. The Magnificent 7 includes Alphabet, Amazon, Apple, Meta Platforms, Microsoft, NVIDIA, and Tesla.
The Mag 7 names made up roughly 28% of the S&P 500 Index to start the year and collectively saw a 48% increase in 2024. Therefore, these names contributed more than half of the S&P 500’s 25% return. This was surprisingly less than the 63% of the S&P’s return they accounted for in 2023. This indicates that the market broadened out slightly, with investors lifting the stocks of non-technology companies that may benefit from the AI revolution. The utilities sector, for example, experienced a notable rally due to elevated electricity demand from data centers essential for AI operations. This sector's strong performance highlighted the expanding recognition of AI beneficiaries beyond the tech industry.
This dynamic of a narrow subset of stocks leading markets higher has posed a significant challenge for many active investment managers who generally are more diversified and have risk constraints around how much they are willing to own in individual names, sectors, and industries.
Other Notable Highlights
Sector Leaders: The communication services, IT, and consumer discretionary sectors performed the best, with the semiconductor industry leading the way.
Real Asset Gains: Gold outperformed equities despite a strong U.S. dollar, showcasing its resilience as a hedge.
Earnings Growth: The earnings growth of companies outside of Mag 7 stocks turned positive in mid-2024, particularly in the financials sector, which saw significant improvements amidst a higher interest rate environment and a strong economy. However, the health care sector lagged due to a slow post-COVID recovery and regulatory uncertainty, experiencing a 10% sell-off in the fourth quarter of 2024.
Quick U.S. Bond (“Fixed Income”) Market Blurb
Fixed income markets faced headwinds as bond yields rose through much of the year, reflecting concerns over economic growth, inflation, and fiscal deficits. The Federal Reserve’s delayed rate cuts, initiated in September, eventually began to ease some pressures, but longer-term yields remained elevated. When investors expect higher inflation or stronger economic growth, they demand higher yields on long-term bonds, which keeps long-term rates elevated. This may explain why you keep hearing that the Fed is cutting rates, yet mortgage rates keep climbing higher. The Federal Reserve can only directly control an overnight short-term rate called the “federal funds rate.”
What is the Federal Funds Rate and How Does the Federal Reserve Control It?
The Federal Reserve (the Fed) controls a specific interest rate called the "federal funds rate." This is the rate at which banks lend money to each other overnight. It's a very short-term rate, usually for just one night. When the Fed cuts this rate, it makes borrowing cheaper for banks. In turn, banks can offer lower interest rates on things like credit cards, car loans, and other short-term loans. However, this doesn't directly affect longer-term interest rates, like those for 30-year mortgages or 10-year bonds, which are influenced by other factors like investor expectations and market conditions.
High-yield corporate bonds outperformed investment-grade bonds, while the yield curve steepened slightly toward year-end.
What is a High-Yield Corporate Bond?
Think of this simply as a higher risk, higher return or higher coupon-paying bond that is generally issued by lower quality, riskier corporate borrowers. They might be in a cyclical industry where the players tend to carry heavy loads of debt and are therefore riskier borrowers. These bonds did well in 2024 because the economy remained quite strong, which quelled investor concerns about the ability of these companies to manage their debt.
Outlook for 2025: Opportunities and Risks
Looking ahead, 2025 presents a mixed outlook for the U.S. equity market, characterized by cautious optimism and heightened uncertainty. Economic growth is expected to normalize as inflation continues its downward trajectory. A soft landing remains the base case, with moderate GDP growth and steady labor market performance.
What is a Soft Landing?
A "soft landing" is when the economy slows down just enough to prevent high inflation without causing a recession. Imagine the economy is like an airplane coming in for a landing. A soft landing means the plane touches down smoothly and safely, without any bumps or crashes. In simple terms, it's when the Federal Reserve manages to cool off the economy just the right amount so that prices stop rising too quickly, but people still have jobs and businesses keep running. It's a delicate balance, like landing a plane gently.
Potential Risks
Policy Uncertainties: Potential tariffs, restrictive immigration policies, and expansive fiscal measures from the new administration could introduce inflationary pressures.
Federal Reserve Limitations: The Fed may face challenges in aggressively cutting rates if inflation resurges due to fiscal or trade policies.
Corporate earnings are projected to grow more evenly across sectors in 2025, reducing the reliance on a handful of mega-cap tech stocks. Analysts anticipate a broadening of earnings growth across all but one S&P 500 sector, supported by recovering U.S. manufacturing activity and lower interest rates. This diversification could ease concerns about market concentration and create opportunities for active investors.
Stock Market Valuations
The S&P 500 is trading at over 22 times forward earnings, well above historical averages. Elevated stock valuations may limit upside potential, making stock selection and diversification critical.
Broader market participation is expected as earnings growth extends beyond the largest companies. In layman's terms, this means that it may not just be the AI-driven, largest mega-cap 7 names driving markets higher in 2025.
Global markets could also play a more prominent role for investors seeking value. U.S. equities have consistently outperformed international markets over the past decade, but their premium valuations now highlight the opportunity in regions like Japan, India, and select emerging markets. Japan’s economy is benefiting from structural reforms and an end to deflation, while India continues to exhibit strong earnings and services export growth. These markets offer attractive long-term prospects, although they may be more vulnerable to short-term volatility.
This does not necessarily mean the future is bleak for U.S. stocks, as it is possible that the market's forward expectation of corporate earnings growth could be understated. There have been many occasions over the past decade where investors believed that the tide was turning and that U.S. stocks would revert to their long-term historical mean averages, only to continue to surge higher.
What are your thoughts on markets in 2024 and the outlook for 2025?
Sources:
State Street Global Advisors: Breaking Down 2024 Market Performance
J.P. Morgan Asset Management: 1Q Economic and Market Update
Russell Investments: 2025 Global Market Outlook
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The information provided in this blog post reflects my personal opinions and does not represent the views or opinions of my employer. This content is for informational purposes only and should not be considered as investment advice. Such views are subject to change at any point without notice. The information in this blog post should not be considered investment advice or a recommendation to buy or sell any types of securities. Readers are encouraged to conduct their own research and consult with a financial advisor before making any investment decisions. Some of the information provided has been obtained from third party sources believed to be reliable, but such information is not guaranteed. I have not considered the investment objective, financial situation, or needs of any individual investor. There is a risk of loss from an investment in securities, including the loss of principal. Different types of investment involve varying degrees of risk, and there can be no assurance that any specific investment will be profitable or suitable or a particular investor’s financial situation or risk tolerance. Any forward-looking statements, opinions, or forecasts are based on assumptions and actual results may vary. No reliance should be placed on, and no guarantee should be assumed from, any such statements or forecasts when making any investment decision. Past performance does not indicate future results.