| YEAR IN REVIEW 2024
2024 felt like a sequel to 2023, with strong gains across most asset classes. The standout, though, was the uneven rally in stocks. US equities dominated, delivering nearly five times the returns of non-US stocks (in dollar terms). The Dow climbed 15%, the S&P 500 jumped 25%, and the Nasdaq led the pack with a 29.6% surge. Fun fact: US stocks have outperformed the rest of the world in 12 of the past 15 years.
Momentum strategies stole the show, with US ‘tech’ giants firmly in control. Nvidia nearly tripled (yes, again), while the broader ‘Magnificent Seven’ group soared by almost 50% in market cap—and they were responsible for about half of the global stock market’s total return in 2024.
The US market kicked off 2024 with a bang, as the S&P 500 ended the first quarter on a high note. A solid U.S. economic backdrop, easing inflation, improving corporate profits, and hopes for Fed rate cuts fueled the rally. Add to that the buzz around artificial intelligence (AI), which gave both Big Tech and smaller AI-focused companies a major boost.
Stocks faced some turbulence in July and August, but the S&P 500 managed its best first nine months of an election year since 1950. Interestingly, what started as Big Tech dominating in the first half began to shift in Q3, as cyclical and defensive sectors like utilities, real estate, industrials, and financials joined the rally.
In September, the Fed made its first rate cut since 2020, marking the end of a relentless tightening cycle aimed at fighting inflation. With this shift, the Fed adopted a more growth-friendly stance, signaling gradual easing to support both the economy and the job market.
Fast forward to November: former President Donald J. Trump returned to the White House for a second term, with Republicans taking full control of Congress. Markets have responded with cautious optimism, hopeful for potential tax cuts and deregulation, but investors are keeping an eye on how issues like tariffs, immigration, and fiscal spending might play out.
In fixed income, US bond funds posted a mixed picture in 2024 as a result of the mixed yield movement. Short-term Treasury products like BIL and BSV are holding steady with modest positive returns over the past year (5.2% and 3.8% respectively), while high-yield corporate bonds (HYG) are leading the pack with a solid 8% annual return. However, there’s a clear duration effect at play – the longer-duration bonds are feeling the pain, especially TLT (20+ Year Treasury) which is down 8.1% over the past year.
Looking at the yield curve dynamics in 2024, we saw a fascinating rotation in rates across different maturities. The long end of the curve (10-year and 30-year) yields have climbed notably from where they were a year ago, with the 10-year yield pushing up by roughly 50 basis points and the 30-year yield showing a similar upward trend. Meanwhile, there’s been a dramatic shift at the short end, with 6-month and 1-year yields experiencing a sharp decline of approximately 100 basis points from their levels a year ago. This inversion has begun to normalize, creating a more traditional upward-sloping curve shape. The stark contrast between the rising long-term yields and falling short-term rates suggests a significant shift in market expectations, potentially indicating growing confidence in long-term economic prospects while near-term rate cut expectations have been priced in.
MARKET OUTLOOK FOR 2025
Looking ahead to 2025, we expect the U.S. stock market to continue its positive performance following two strong years of double-digit gains. There are six key factors we believe will shape the performance of both stocks and bonds moving forward.
1. Goldilocks economy with moderate growth, full employment and low inflation
The U.S. economy is currently in a “Goldilocks” state—just the right mix of growth, full employment, and low inflation. With real GDP growing around 3% annually, near full employment, and inflation under 3%, the economy isn’t too hot to trigger inflationary pressures or too cold to slow down consumer spending. The result? Most households feel financially confident, bolstered by rising asset values, and are in a good position to keep spending.
• Moderate economic growth – After a sluggish start to the year, the U.S. economy has exceeded expectations in 2024, with GDP growth expected to hover around 3%. Looking ahead to 2025, while economists are optimistic, growth is expected to moderate to the economy’s long-term trend of about 2%. With solid momentum heading into year-end, there’s still some softness in the labor market. However, we expect the economy to continue growing sustainably over the next five years, fueled by productivity boosts (think AI and automation) and capital investment from global investors.
• Low Inflation = Fed Rate Cuts – With inflation under control and signs of slowing job growth, the Federal Reserve started cutting rates in September 2024. After a 0.25% cut in December, the Fed has now reduced short-term rates by 1% in total. While Fed Chair Powell hinted at a pause in January to assess conditions, it’s clear that rates are still tight, and more cuts are expected in 2025—likely two more 0.25% reductions. The overall picture? A manageable economic environment with room for growth and easing monetary policy.
2. Trump pro-growth policies to drive cyclical recovery
With Trump returning to the White House, we’re likely to see a fresh wave of pro-growth, business-friendly policies that should help fuel a cyclical recovery, particularly for sectors like financials and industrials. Here’s a quick look at some of the key promises from his campaign:
• Lower Taxes – Trump’s pushing for tax cuts on tips and Social Security benefits, along with a break for corporations. This is designed to put more money in the hands of businesses and consumers, stimulating growth.
• Less Red Tape and More M&A – Expect a reduction in regulations, which could pave the way for an uptick in mergers and acquisitions, especially in sectors looking to consolidate or expand.
• Boosting Domestic Manufacturing – Trump is likely to double down on his “America First” strategy, offering new or enhanced tax incentives and subsidies to bring more manufacturing jobs back home. He plans to tackle any potential inflationary pressures by pushing for greater automation and reducing energy costs.
• Lower Energy Costs – A major focus will be on cutting energy costs, potentially by ramping up oil and gas production and easing restrictions on power plants. Lower energy prices could help reduce overhead for businesses, further supporting economic growth.
Overall, these policies could provide a solid foundation for growth, especially in cyclical sectors that thrive in periods of recovery.
3. AI innovation to drive massive productivity gain in the medium term
The U.S. economy is currently facing a major growth challenge due to a widespread labor shortage across nearly every sector, from tech and manufacturing to services. With unemployment at just 4.2%, the labor market is tight by historical standards. But there’s a game-changing solution on the horizon: AI innovation. We believe AI will unlock significant productivity gains and help address this labor shortage by enabling businesses to use capital to complement or even replace human labor. This represents a transformative shift in the economy—essentially a once-in-a-century revolution in how industries operate.
The U.S. is particularly well-positioned to benefit from this shift. With relatively high labor costs and lower capital costs compared to other countries, the return on investment for AI adoption is especially attractive here.
The scale of the opportunity is truly massive. Globally, the white-collar labor market is worth an incredible $30 trillion annually—100 times the size of the $300 billion enterprise software market. For many U.S. multinationals, there’s huge potential to enhance labor-intensive functions like sales, marketing, finance, customer service, operations, and HR with affordable, AI-powered solutions. The result will be unmatched efficiency, scalability, and a complete economic transformation that could reshape entire industries.
4. Good risk/reward profile for the bond market
With the 10-year Treasury yield hovering around 5%, investors are once again being reasonably compensated for taking on interest rate risk. The bond market is pricing in long-term inflation expectations of about 2.3%, meaning investors are targeting a 2.3% real (after-inflation) return from the 10-year note. This expected return is in line with the average from 1999 to 2008 and slightly above the 2.1% median during that same period. While bonds aren’t exactly “cheap” right now, they’re offering a solid risk/reward profile and could serve as a strong diversifier if stocks take a hit due to an economic slowdown. With consumer inflation (CPI) at 2.7% year-over-year, we expect it to moderate over time. Even if inflation remains stable, bonds should still deliver a decent after-inflation return.
5. Interest rate projected cut to push more cash into the bond and stock markets
Drawn by the attractive 5% interest return, investors have flocked to the money market funds since 2023 driving it to reach a total of $6.8Tr outstanding today. With the projected Fed rate cut towards sub-3% inflation rate, investors are likely to reverse course in 2025 re-allocating some of these funds to the bond and stock market. As interest rate and cost of capital drop, pent-up demand for capital investments and big ticket item purchases will likely recover. We expect many purchases financed by loans such as housing, automotive, appliance, solar to see a cyclical recovery in 2025. Therefore, stocks in cyclical sectors may rebound as the market anticipates a recovery.
6. Some downside risks as the market is over-valuing near term growth
The biggest near-term risk to the stock market right now is valuation. The S&P 500’s forward 12-month P/E ratio is currently around 21, which is higher than both the 5-year average of 19.4 and the 10-year average of 18.0, according to FactSet. This elevated valuation suggests that the market is pricing in solid earnings growth over the next 1-2 years, as well as the stronger fundamentals of S&P 500 companies—such as lower cyclicality, higher return on equity (ROE), better profit margins, and improved growth prospects.
For 2024, the S&P 500 is expected to see strong year-over-year earnings growth of 9-10% (with the “Magnificent Seven” stocks projected to grow 33% and the rest of the index, or S&P 493, growing 4%). This performance underscores the resilience of U.S. companies, even amid challenging global economic conditions. Looking ahead to 2025, earnings are forecasted to grow around 15% (with the Magnificent Seven at 21% and S&P 493 at 13%). This growth outlook is well above the 10-year average of 8% (2014-2023) and is expected to be driven by a recovery in cyclical earnings, AI-enabled productivity gains, and steady or declining interest costs.
PORTFOLIO STRATEGY FOR 2025
As we head into 2025, investors should take a moment to reassess their risk tolerance. The strong two-year stock rally has likely increased their exposure to riskier assets, making it a good time to rebalance stock and bond allocations back to target levels.
We remain highly confident in the U.S. market and the technology sector over the medium term. While the “Magnificent Seven” stocks are drawing a lot of attention, it’s crucial to maintain diversification across sectors (like energy and healthcare) and asset classes (such as infrastructure and gold). Keeping a portion of your portfolio in more stable or income-generating assets can provide a buffer during market volatility, helping investors avoid the need to sell stocks at the wrong time.
We believe the stock market has priced in most of the near-term growth potential. Therefore our portfolio needs to be very agile in case the market momentum turns in 2025. However, the medium-term earnings potential for the S&P 500 remains strong, with the payoff from current AI investments expected to show up in earnings 2-5 years down the road. For long-term investors with a 5+ year horizon, there’s still significant upside to be had. |
