Executive Summary
- The S&P 500 registered its best two-year return in more than 25 years
- S&P 500 corporate EPS is forecasted to grow 9.4% in 2024 and 14.8% in 2025
- Rates are rising in the face of 100 basis points (bps) in FFR cuts
- The Federal Reserve is front-running Trump policy in latest SEP projections
- The greenback is surging to two-year highs
“So let me say that in the near term, the election will have no effects on our policy decisions.” – Chair Jerome Powell, November 7th FOMC Press Conference
“Some people did take a very preliminary step and start to incorporate highly conditional estimates of economic effects of policies into their forecast at this meeting and said so in the meeting.” – Chair Jerome Powell, December 15th FOMC Press Conference
The U.S. stock market powered higher in 2024 with the major equity benchmarks posting double-digit returns amidst a positive backdrop of strong economic activity, robust corporate earnings growth and easing monetary policy by global central banks.
Economic data showing strong GDP growth (+2.7% YoY), low unemployment (4.1%), increased consumer spending (+3.7%), and falling inflation (core-PCE +2.8% YoY) removed any recession fears lingering from the prior year’s rate hiking cycle (+525bps). Corporate profits accompanied the rising economic tide with S&P 500 earnings expected to grow 9.4% in CY 2024 and 14.8% in CY 2025, according to FactSet. While inflation has yet to reach the Federal Reserve’s 2% threshold, its declining trend provided the FOMC enough cover to pivot from its restrictive policy with three rate cuts totaling 100bps over the final three meetings in 2024.
In CY 2024, the top performing Nasdaq Composite (+29.6%), Nasdaq-100 (25.9%), and S&P 500 (+25%) indices were propelled higher from another gangbuster year by the Magnificent Seven (+67.3%). Over the last two years, the broad-based S&P 500 had a total return of 57.8%, its strongest two-year return in over 25 years (1998) and fifth best since at least 1970 (54 years). The Nasdaq-100 gained 95.3% for its fifth best two-year return since inception (38 years), while the Magnificent Seven Index had a two-year return of 246.4%.
Smaller caps performed well on an absolute basis with the S&P Midcap 400 (+13.9%) and Russell 2000 (+11.5%) registering double-digit gains, albeit each index meaningfully underperformed the large, market-cap weighted indices. They did however perform more in line with the S&P 500 equal weight (+13%) and Nasdaq 100 equal weight (+7.3%) indices.
Accordingly, large-cap growth represented by the Russell 1000 Growth Index (+33.4%) meaningfully outperformed small-cap growth (+15.1%), large-cap value (+14.3%), and small-cap value (+8%).
Ten of 11 large-cap sectors finished higher in 2024 including four gaining more than 30%. The top performers were Communications (+40.2%), Technology (36.6%), Financials (+30.5%), and Discretionary (+30.1%). At the other end of the performance spectrum were Materials (-0.04%), Healthcare (+2.6%), and REITs (5.2%).
In similar fashion, ten of 11 small-cap sectors finished higher, including five gaining more than 15%. Technology (+23.6%), Staples (+21.2%), Communications (+19.1%), Industrials (+17.2%), and Financials (+16.6%) were the top performers while Energy (-6.1%) was the only sector in the red.
While the Magnificent Seven drove the outperformance of the major equity indices, robust gains were also seen across numerous industries including the KBW Bank Index (KBWB ETF, +36.7%), Clouding Computing (SKYY ETF, +35.9%), Broker-Dealers (IAI ETF, +34.4%), Software & Services (XSW ETF, +25.8%), Cyber Security (HACK ETF, +23.5%), and Aerospace & Defense (XAR ETF, +23.3%).
Rates & The Fed
It was a roller coaster year for rates and timing the start of the rate cut cycle. At the start of 2024, markets were pricing seven 25bp rate cuts by year end. Over the next four months into early May, the hawkish repricing of rates led to markets pricing just one 25 bp rate cut by year end. In mid-summer, softening economic data swung the pendulum back towards a dovish repricing of rates. By year end, the Federal Reserve cut the overnight FFR by a total of 100bps across three meetings in September (50bps), November (25bps) and December (25bps). The short end of the Treasury curve was lower in CY 2024 while the belly of the curve, starting with the 3yr, out to the long end 30yr, moved higher.
The 50bps cut in September was soon followed by the UST 10s,2s spread emerging from a record 26 months of inversion into positive territory (bear steepener).
Ironically, rates moved sharply higher following the September FOMC into the end 2024. Over this time, the UST 10yr Yield rose 93bps, from 3.65% to $4.58%, while the UST 2yr Yield rose 63bps, from 3.61% to 4.24%. Some critics were quick to attribute the spike higher in rates as a policy error by the Fed, however other market interpretations are more likely.
The UST 10yr and 2yr yields declined a steep 100bps and 140 bps in the prior five months heading into the September FOMC due in part to slowing macro data during the summer. The Fed was criticized for not cutting rates at the July 31st FOMC after the following week’s economic data revealed the monthly unemployment rate (July) spiked from 4.1% to 4.3%, versus expectations of 4.1%. This triggered the Sahm Rule recession indicator which was immediately followed by a steep decline in rates when investors bought “recession insurance” via safe-haven Treasuries. At the next FOMC in September, the Fed responded affirmatively in both action and words by cutting rates 50bps and Chair Powell declaring clear support for the economy, “Overall, the economy is in solid shape. We intend to use our tools to keep it there.” The Fed’s strong response led to an unwind of the “recession insurance” trade triggering the move higher in rates.
At the November FOMC, Chair Powell said the presidential election will have no effect on our monetary policy decisions and accordingly the uptrend in rates stalled over the next four weeks. Animal spirits were in high gear all month led by double digit returns in small caps. Market breadth was strong with all eleven large and small-cap sectors finishing higher, and both the S&P 500 (+5.9%) and the Russell 2000 (+11%) had their best monthly performance in 2024.
The Federal Reserve’s reaction function changed in a hawkish direction at the December FOMC, where Chair Powell emphasized a greater balance between inflation and labor relative to the prior meetings concern for softening economic data (i.e. labor). Powell also noted some members were starting to incorporate economic effects of the incoming Trump administration (i.e. inflation). While the Fed’s quarterly SEP projections (December) included marginal changes for YE 2025 GDP and Unemployment, its outlook on inflation and the Fed Funds Rate was more pronounced. YE 2025 core-PCE rose 0.3% to 2.5%, its biggest quarterly change in over a year, while the FFR increased 0.5%, from 3.4% to 3.9%, implying just two 25bp rate cuts in 2025 from the prior SEP projection of four.
Equities responded accordingly by reversing sharply lower in December, where all eleven small-cap sectors and eight of eleven large-cap sectors finished in the red. Once again, one of the few pockets of strength came from the Magnificent Seven Index which gained 6.3% in December.
Looking Ahead
According to FactSet, S&P 500 corporate earnings grew 5.9% YoY in Q3 for its 5th consecutive quarter of positive earnings growth. For Q4, S&P 500 EPS is expected to grow 11.9%, which would be its best quarter since Q4 2021. For CY 2024, S&P 500 EPS is expected to grow 9.4% on revenue growth of 5.1%, while CY 2025 EPS is expected to grow 14.8% on revenue growth of 5.8%.
While corporate earnings are strong and strategists are forecasting GDP to grow 2.1% in CY 2025 versus 2.7% in CY 2024, there is a growing list of uncertainties markets will have to contend with in 2025 that can lead to increased volatility. The effects of the incoming Trump administration’s policies on tariffs, immigration, deregulation, tax cuts, geopolitics, and fiscal spending vary significantly amongst forecasters. The Fed’s recent shift towards a slower pace of rate cuts is front running the new administration’s policies. Interest rates are rising despite the 100bps of rate cuts, and the average 30year fixed mortgage is above 7%. Just in the last week, the US Dollar Index (DXY) broke out to fresh two-year highs which is an increasing headwind for foreign companies and corporations. If both rates and the greenback remain elevated at these levels or higher, that could lead to weaker economic activity both locally and abroad.
The information contained herein is provided for informational and educational purposes only, and nothing contained herein should be construed as investment advice, either on behalf of a particular security or an overall investment strategy. All information contained herein is obtained by Nasdaq from sources believed by Nasdaq to be accurate and reliable. However, all information is provided “as is” without warranty of any kind. ADVICE FROM A SECURITIES PROFESSIONAL IS STRONGLY ADVISED.
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