Where Are We? A Summary of 2024

I have always been enamored with complex econometric techniques; they always gave me a feeling that I could get a glimpse of the future. I loved writing programs to collect and process economic data from all over the place. I would use fancy methods like principal component analysis to reduce the dimensionality of the huge datasets and feed them into vector autoregressions to try to have my model spit out some forecast of the future. For anyone that has explored these models, eventually (hopefully) you come to the conclusion that these models are more useful for studying past relationships rather than actually forecasting the future. This is largely due to what I call compounded uncertainty: in economics and financial markets, we are tasked with forecasting the future, yet much of the time, we lack a clear understanding of our current position. It’s hard to forecast the future if you do not know the exact point from which you are forecasting from. As an economist, I have found it much more useful to spend my time studying where we are rather than trying to spend my time figuring out where we are going. Usually, discovering where we are will provide some guidance on the optimal steps to take given the current market environment. As we welcome the New Year, a time when we usually look ahead and make our “New Year’s Resolutions,” I’ve decided to take a moment to look back instead.

In this article, I’ll review the key items that caught my eye over the course of 2024 in financial markets, technology, and the overall economy.

The “Stock Market”: The S&P 500 returned 25.9% (See Figure 1) in 2024 making it the 12th best returning year since 1970 outranking the 24.7% return achieved in 2023 (now the 13th best year). The rally in 2024 took the S&P 500 past 6,000 well beyond the record set in 2021 of 4,808. The core headlines that drove the rally in 2024 were around advancements in artificial intelligence (AI) and the slowing of inflation back towards the Federal Reserve’s target level of 2% per year. In the opening of this paragraph I have put “Stock Market” in quotes for a reason.

Figure 1 S&P 500 cumulative annual returns from the start of each year since 1970 is plotted in grey. 2024 has been highlighted in green. 2024 ranks as the 12th best year since 1970.

The S&P 500 has historically been a proxy that is used by market participants to gauge the overall performance of companies in the United States. After all, it is a seemingly diverse index with over 500 companies! However, the index is constructed as a market-capitalization weighted index, where the largest companies hold the largest weight. As of the end of 2024, the top-ten constituents of the S&P 500 account for nearly 40% of the index’s weight. As a result, the index has become a bit detached from the majority of the US economy as more and more weight is placed on the technology behemoths. The graph in Figure 2 depicts the weight of the top-ten stocks held by SPY, an exchange traded fund that tracks the S&P 500 over time. If you feel that you have a diversified portfolio by just owning a fund that tracks S&P 500 I urge you to take another look at your portfolio; you are more exposed to a handful of securities than you might think you are.

Figure 2 The amount of weight the top-10 companies account for in SPY. Index concentration is increasing.

Figure 3 Training loss as a function of total compute Hoffmann et al (2022).The colors represent model complexity based on the number of parameters. More compute ? ?Model Better. Read more at https://arxiv.org/pdf/2203.15556

AI: A study by Hoffmann Et. Al in 2022, showed that large language models (those such as ChatGPT, Gemini, etc.) are undertrained; meaning the models continue to improve with more compute resources (see Figure 3). This finding has been central to an AI arms race among technology companies to secure as much compute as possible. Whoever has the most computing power is most likely to have the ‘smartest’ AI system. The biggest beneficiaries of this have been semi-conductor manufacturers and of course graphics card producers such as NVIDIA. The record sales of these industries has setoff rally’s throughout the tech sector that propelled the S&P 500 to record highs. Looking back at this moment is most like an inflection point in history where we may finally be on a track to having a super intelligent, or, artificial general intelligence (AGI). Each day performance is increasing as we are entering a never ending cycle of enhancement. We can use the latest AI model to review the code that was used to generate the AI model and have the AI model make recommendations to enhance itself. We have an evolutionary system in place that is in a recursive loop of improvement. The rise of AGI will have profound long-term effects on the way live and work; this is a deep philosophical issue that will shape the next generation that I urge everyone to read more about. One thing I am certain of is that we have entered the age of abundant intelligence. There is no going back from here. A starting point to read further on this topic is Co-Intelligence: Living and Working with AI by Ethan Mollick and Ray Kurzweil’s The Singularity Is Near: When Humans Transcend Biology.

Figure 4 A Decomposition of Consumer Price Index for All Urban Consumers: All Items in U.S. City Average.

Inflation: As of November 2024 inflation as measured by the consumer price index (all urban consumers/all items) was + 2.7% year over year from November 2023. As shown in Figure 4 there has been meaningful progress on the slowing of inflation from the over 8% peak that we experienced in 2022 as a result of COVID-19 where fiscal stimulus combined with supply chain disruptions led to surging prices (stimulated demand with reduced supply leads to higher prices – textbook macroeconomics). Supply chains have steadily come back online globally easing supply and the federal reserve began aggressively raising the short-term federal funds rate in 2022 to help slow demand. Combined these two effects have slowly started to lead to a slow down in price increases despite continued enormous fiscal spending. As can be seen in Figure 4, there was a large spike in inflation coming from increased transportation costs that has gradually disappeared.

Housing: The stickiest component of inflation has been in Owners’ Equivalent Rent (OER): the amount of rent that the Bureau of Labor Statistics imputes a home owner would have to pay if they otherwise did not own their home. OER is shown in Figure 4, the orange bar. My dissertation advisor, mentor, friend, and person I forever look up to, Dr. John Rutledge was the first person I know of to catch the stickiness of OER and correctly predicted that the Federal Reserve would begin cutting rates in 2024. As of November 2024, removing OER from overall CPI would actually place the CPI numbers at 1.41% indicating that price level excluding ‘estimated housing rents’ is actually growing at a slower pace than the Federal Reserve’s target. There is further confirmation that OER is expected to slow in growth as measured by the months’ supply of new homes available in the United States. The latest estimates using the November released data is 9-months’ supply of new homes (it would take nine-months to sell the existing stock of new homes at the current sales velocity). To place that number in perspective, during the 2008 financial crises there was 12-month’s supply of new homes in the United States (See Figure 5).

Figure 5 Months’ Supply of New Homes in the United States.

Combining all this information, while inflation has been a discussion in everyone’s household (including my own) prices seem to be back on a stable path and the Federal Reserve is cutting interest rates to start re-stimulating demand.

Misery? A nice way to visualize where the economy currently stands is the Misery Index as originally proposed by Arthur Okun which combines the Unemployment Rate with the annualized inflation rate (See Figure 6). The Misery Index, while below the historical average of 5.72%, has steadily increased from a low of 3.44% in April 2023 to 4.22% in November 2024. I mentioned in the previous paragraph that inflation has been declining; the increase in the Misery Index has been from a rise in Unemployment which increased from a low of 3.4% in April 2023 to 4.2% in November 2024. While unemployment has increased, we are still at relatively low levels and not at a level to be concerned with at this point. We seem to be in a sweet spot where unemployment is reverting back to the so-called “natural level” and inflation is working its way back down towards pre-pandemic levels. Given the sort of Goldilocks state that the unemployment and inflation data are indicating it is worthwhile to take a deeper look under the hood and see what’s really going on in the underlying data. A lot of people are feeling left behind by the seemingly endless increase in prices and the surge in asset prices has built a larger wealth gap that is fueling increased inequality. Perhaps the Misery Index is missing a few things.

Figure 6 Arthur Okun's Misery Index from January 1948 through November 2024. Unemployment Rate + 12-month % change in consumer price index all urban consumers.?????????????????

The Economy: The term economy is thrown around to mean all sorts of things. One approach is to look at the total income in a country. There is actually a simple accounting identity that sums up the total amount of economic activity in a country (Gross Domestic Product). The total amount of economic activity really just the total of consumption (C), investment (I), government expenditure (G), and net exports (NX). Funny enough, as I am writing this article on December 30th 2024, ?the latest data for each of these categories is only available through July 2024, which brings back to the forefront the importance of studying where we are at given time rather than spending time guessing where things are likely to go. The below figures track each component of the United States Gross Domestic Product compared to the previous 8-years. For example, if consumption is at the highest (lowest) value in the past 8-years that would be 100% (0%) score in the graphs below. In each graph, I have highlighted in blue past recessions.

Consumption: I have decomposed consumption into three categories in Figures 7 through 9 below into non-durable (perishables), durable (cars, boats, etc), and services (haircuts, doctors’ visits, etc.) consumption. We can see that individual consumption is way down for non-durable and durable items ?and is steadily declining for services. If you’re feeling like you are consuming less than the past, you’re not alone.

Figure 7 Consumption of non-durable goods such as foods, fuel, energy, etc is slowing compared to the previous 8-years.

Figure 8 Consumption of Durable Goods has nose-dived following high inflation levels and high interest rates.

Figure 9 Consumption of services remain elevated but have also been on a downward trend.

Investment: Investment activity is typically a function of interest rates. As interest rates fall (rise), the cost of borrowing money declines (increases), usually leads to increased (decreased) investment activity. 2024 has been an extremely volatile year for interest rates as investors are still struggling to decide if inflation has truly abided, or, if there is some underlying risk of inflation re-surfacing. The Ten-Year Treasury rate peaked at 4.7% in April before gradually declining to 3.5% in September. Following the first cut by the Federal Reserve bank in the Effective Funds Rate the Ten-Year Treasury rate has been climbing non-stop back to close the year around 4.7%. The increase in interest rates is slowing investment activity as shown by the slower growth in investment activity in Figure 10.

Figure 10 Growth in investment remains at average levels but remains volatile given large fluctuations in interest rates.

Government: Fiscal spending is slowing but remains above average and is still in the 80th-Percentile compared to the previous 8-years as shown in Figure 11. Government spending is the definitive factor keeping demand in the economy alive at the moment. As we saw in the previous two sections both consumer and investor spending are below historical averages. There remains a lot of uncertainty around the incoming Trump administration. Trump ran on the promise of reducing government regulations and eliminating ‘big government’. While he has actively stated this position and has gone so far as to create a “Department of Government Efficiency” which should lead to less government activity the Ten Year Treasury rate has continued to climb following election night. As stated at the start of this paragraph, Government spending (yes capital G) has been playing a strong role in keeping economic activity afloat as consumers and investors have both stepped back from their pandemic level activity.

Figure 11 Government spending remains elevated compared to the previous 8-years.

Conclusion: 2024 has been a year defined by contrasts and inflection points. The “stock market” has surged to record highs by a few companies that are leading the advancements in AI, even as economic fundamentals are showing signs of strain. Consumer caution (reduced growth in durable and non-durable spending), rising unemployment, and volatile interest rates have slowed investment spending. The acceleration toward artificial general intelligence promises to reshape industries and redefine work, while fiscal and monetary policies will set the stage for economic recovery, or, stagnation. While this is occurring, the widening wealth gap and social disparities demand attention and action. These core economic themes are the key elements the incoming Trump administration was able to tap into leading to their sweeping victory in the 2024 election. Social disparities are likely to be further exacerbated by advancements in AI in the short-term as early adopters reap the low hanging fruits. In the long-term, I am confident that we will enter an age of abundance as advancements in AI will certainly be deflationary. Once we all have a super intelligence in our pocket, we’ll be able to figure out anything we want. Why buy anything when your super intelligent AI can make it for you?

I hope that by reading this brief summary of 2024 you have a bit of a clearer understanding of where we stand. I’ll end with the below quote that I was able to get ChatGPT to write

“The future remains bright because it is not written yet; we hold the pen and the power to shape it with every choice we make.” – ChatGPT-4o

Figure 12 Welcome to the age of abundant intelligence.