Market Review
What a year…again! The benchmark S&P 500 index closed the 4th quarter up 2.1%, following on a 5.5% gain the prior three months and leaving the benchmark with a second-consecutive year of 20+% gains for only the sixth time since 1950. The index hit 57 new all-time closing highs in 2024, a mark only topped 5 times in the last 70 years. Third-quarter corporate earnings beat analyst forecasts by almost 7%, growing around 8.5% year-over-year. Revenues surprised to the upside by slightly more than 1%, growing over 5% versus the prior year. Analysts project that earnings grew around 7.5% during the 4th quarter and will grow more than 14% in 2025, with double-digit earnings growth in each quarter but the 2nd. The Federal Reserve (“the Fed”) cut their policy rate twice during the 4th quarter, moving that target rate by 0.25% on each occasion, after an initial 0.50% rate cut at their September policy meeting. Fed Chair Powell characterized the current monetary policy stance as remaining restrictive, but stressed a willingness to be patient regarding further policy recalibration with year-over-year inflation stubbornly above the central bank’s 2% target and US economic growth remaining resilient.
The Economy
The U.S. economy expanded at an above-trend pace of 3.1% during the 3rd quarter, after consensus began the quarter calling for a below-trend 1.6% growth rate. Per the Federal Reserve Bank of Atlanta’s GDPNow model estimate, 4th quarter growth is tracking in-line with 3rd quarter growth, almost a full 1% above economist projections and more than double the growth anticipated at the start of the 4th quarter. Third-quarter inflation readings on the central bank’s preferred Core Personal Consumption Expenditures Deflator continued to trend toward the stated 2% target year-over-year, providing policymakers confidence they could cut their policy rate twice. The Fed’s post-meeting statement after easing policy in December indicates they feel their policy stance is considerably less restrictive than prior to September’s initial rate cut and the two subsequent policy adjustments. Economists anticipate the US economy will grow an on-trend 2% during 2025, which would mark a roughly 1% slowdown versus each of the prior two years. The unemployment rate has risen almost 1% versus the cycle low of 3.4%, but remains quite low by historical standards.
Equity Markets
The S&P 500 beat seven of 11 sectors during the 4th quarter, which serves to illustrate that it matters which sectors investors overweight and which sectors those same investors underweight. That being said, the sectors that topped the benchmark represent roughly ⅔ of the index’s market value, or market capitalization (“market cap”). Consumer Discretionary (+14.1%) topped sector returns by a sizable margin on the back of strong holiday spending in spite of what is quite literally as short a shopping period as there can be between Thanksgiving and Christmas Day. Consumer spending remains value-driven after the inflation of recent years, but a solid job market means that consumers are willing to spend. Communication Services (+8.6%) saw tailwinds from streaming content platforms, with some newer offerings turning profitable, and a number of 2024 box office blockbusters.
It never comes as much of a surprise to see Tech (+4.7%) among the top sectors. Artificial Intelligence (A.I.) continues to garner attention and investment dollars, with large-scale Cloud service providers spending heavily on A.I. infrastructure. That infrastructure turns into revenue for those providers, and attention begins to turn to Cloud users monetizing their expenditures for using that infrastructure. Financials (+6.7%) also topped the S&P 500 on expectations the incoming administration will adopt a lighter regulatory touch. Healthcare (-10.7%) was a notable laggard, with election uncertainty initially weighing on the sector, as is typical in election years, and then the incoming administration’s healthcare appointments being seen as comparatively less favorable for Pharmaceutical companies. Investors often view Utilities (-6.2%) and Real Estate (-8.7%) as bond-proxies, given their generous dividend payouts, and sharply higher long-term interest rates weighed on those sectors and on bond prices. Industrials (-2.7%), Energy (-3.2%) and Materials (-12.8%) lagged as the incoming administration’s proposed tariff-heavy trade policies may pose headwinds for companies who generate large portions of their revenues in international markets. In addition, US economic growth looks far more durable than growth in other regions of the world.
Long-Term View
Given stable-to-falling inflation, higher long-term interest rates would seem to indicate a higher level of optimism on economic growth, which would fit well with the 4th quarter strength in companies that benefit from non-essential spending. US consumers tend to spend when they’re working and getting paid, and by history’s measure, employment is strong. A.I. investment will likely continue to boost economic growth, and those investments could also enhance productivity to provide additional economic momentum. Even with the 4th quarter spike in long-term interest rates, yields remain a good bit below the cycle peak and relatively low by historical standards. Resilient economic growth would definitely provide a tailwind toward companies meeting expectations for double-digit earnings growth in 2025. Those expectations set a high bar for 2025 results to match or even beat, as current stock prices reflect expectations of future earnings. As ever, it’s likely that companies that hit or top expectations will see their stock prices rewarded versus the broader market, and companies whose results fall short will likely see their stock prices lag the broader market, dramatically so in some cases. It takes an optimist to invest in stocks priced on future earnings, so investors would be wise to trust the long-term upward trend in stock prices but verify execution in company results.
