January 2025 Market Commentary

For the period December 1 – December 31, 2024.

Executive Summary

While the Santa Claus rally failed to materialize, the S&P 500 finished the year 23.1% higher, the first back-to-back annual 20%-plus gains since 1998. The outlook for 2025 remains broadly optimistic, but several wildcards could dampen the mood.

What Piqued our Interest

Despite the modest pullback in the final weeks of December, the 4th quarter of 2024 was strong for U.S. equities overall, capping off two second consecutive years of historically significant gains for the major large cap indices. It would have been difficult to best November’s massive post-election rally, so instead, most markets took somewhat of a breather as 2024 came to a close. We now look toward 2025 and what the incoming administration means for the economy as well as both stock and bond markets.

There is a lot of optimism among the universe of sell-side analysts and various financial practitioners. Bank of America’s December Fund Manager Survey reflected a super-bullish tone, based upon further rate cut expectations and a pro-business Trump 2.0 agenda that could include deregulation and tax cuts. The survey indicated that the average cash holding for allocators fell to just 3.9% of assets under management, the lowest since June 2021, showing that portfolio managers are in a “risk-on” mood. It should be noted however that cash levels below 4% can be viewed as a contrarian sell-signal as investors become overly complacent.

Another key takeaway from the survey was the surge in investors’ U.S. bias. U.S. equities have notably outperformed both developed and emerging markets for years, but in December the net percent of asset allocators who indicated they were overweight U.S surged to 36%, the highest level on record (and two standard deviations above the long- term average). In addition to a favorable business environment in the U.S., sentiment on European equities has deteriorated as of late, which, along with continued strength of the U.S. dollar, has created headwinds for international stocks.

Despite the optimism surrounding U.S. stocks, and technology stocks in particular, there are several potential catalysts that could be a source of increased volatility in the new year. The mid-December pullback was initiated by hawkish comments from the Fed following the most recent Federal Open Market Committee meeting, signaling fewer rate cuts in 2025 than previously expected. Persistent inflation (driven by resilient consumer spending, a shortage in housing supply, and years of fiscal excess) still remains well above the Fed’s target and could increase in the year ahead. While too soon to know for sure, the potential for higher tariffs and decreased labor could put upward pressure on prices in the short term.

The threat of a possible resurgence of inflation has the Fed rethinking their plans for rate “normalization” in 2025. Back in September, the Fed’s dot-plot (which graphically depicts the median expectation for rates in the future) called for rate cuts to 3.25%-3.5% by year end. After cutting rates by a quarter percent at each of the last two meetings, the December 2025 dot plot now calls for year-end rates at 3.75%-4.0%, a half percentage point higher than three months ago. Fed futures also show only one 25 basis point cut fully baked in, reflecting the uncertainty that awaits as the new administration’s policy unfolds.

Market Recap

As the chart depicts, most equity indices pulled back in December but still produced solid gains for the year. Bucking the trend last month were both the Nasdaq 100 and Russell 1000 Growth, two indices with notable and significant overlap. For the year, the large cap growth index outperformed its value counterpart by roughly 19% and has averaged nearly 5% higher returns over the past three years. We note that the Russell 2000 (small cap index) took a notable step back last month, after surging in November, but still finished at +11.54% on the year. The blue-chip Dow Jones Industrial Average ended the year at a very respectable +14.99%, but trailed the S&P 500 by just over ten percentage points.?

International stocks modestly declined in December to finish off a mostly mediocre year, especially when compared to the results here in the U.S. The MSCI Emerging Markets index finished at +7.5%, roughly double that of the MSCI EAFE (which tracks developed countries), which returned only +3.82%. U.S. dollar strength was a continuous headwind for many international stocks, as the ICE U.S. Dollar index gained about 6% against a basket of major currencies. Finally, it was yet another challenging month for fixed income overall, as the Bloomberg U.S. Aggregate Bond Index finished the year at +1.25% from a total return perspective.

Closing Thoughts

Building upon the fixed income recap, bonds suffered losses in December as the yield curve meaningfully un-inverted, as rates on 1-year bonds all the way out to 30-year increased up as much as 0.40%. While the curve is still inverted out to one year (which correlates with Fed rate cut expectations), yields for maturities that are further out on the curve reflect the market pricing in expected growth, and potentially, higher inflation.

This is meaningful in the sense that the yield curve is now positively sloped for the first time since late 2022, which bodes well for investors looking to ladder their bond portfolios. Higher yields on the longer end of the curve look attractive to investors looking to source income or looking for protection against unanticipated volatility. As many investors know, the yield curve is a very poor tool when it comes to timing the market. And it's worth noting that historically, economic recessions don’t occur when the curve inverts, but rather several months after it un-inverts. This, of course, is not our way of calling for a recession, but rather a timely reminder of why investors should be cautious amongst the abundant optimism prevalent today. Along with many practitioners and economists, we foresee another year of modest but healthy economic expansion, but that doesn’t mean we won’t see a few market disruptions along the way.

This information is not intended as a recommendation. The opinions are subject to change at any time and no forecasts can be guaranteed. Investment decisions should always be made based on an investor's specific circumstances.