Equity markets rose during the final quarter of the year, fueled by expectations of pro-growth policies under the incoming Trump administration, along with ongoing hopes for lower interest rates and optimism for companies exposed to artificial intelligence. The S&P 500 returned 2.4% during the fourth quarter, bringing the total return for 2024 to 25%. This marked the best consecutive two-year period for the index since the late 1990s. The bond market, however, faced downward pressure due to renewed inflation concerns. As a result, the Bloomberg U.S. Aggregate Bond Index fell 3.1%, ending the year with a total return of 1.3%. U.S. large-cap stocks resumed their place as the best performing asset class during the quarter, handily outperforming small- and mid-cap stocks, which barely registered a positive return. In a stark contrast to U.S. equities, international stocks posted a negative return amid concerns that proposed tariffs could pose risks to economies abroad.
The primary drivers of the equity market over the past year mirrored those of 2023: optimism surrounding mega-cap technology companies heavily investing in artificial intelligence and expectations for interest rate cuts by the Federal Reserve. The ‘Magnificent Seven’ tech giants were pivotal in driving much of the S&P 500’s gains, propelled by above average earnings growth and the potential for even greater profits from their AI initiatives. However, this trend is beginning to show signs of moderation, as earnings growth among these leaders slows and the gap in performance relative to the broader index narrows. While enthusiasm remains elevated for this small cohort of stocks, we believe the market will need to rely more on sustainable earnings growth for the broader S&P 500 to continue its momentum into the new year.
During the fourth quarter, the Federal Reserve lowered interest rates by 0.25 percentage points at both of its meetings, bringing the total reduction in the federal funds rate to 1% since the first cut in September. In the final meeting of the year, the Fed surprised financial markets by lowering its forecast for rate cuts in 2025, triggering a sell-off in stocks and a rise in bond yields. Inflation, which had been trending downward for most of the year, began showing signs of stalling at levels well above the Fed’s 2% target. Similarly, while the labor market was gradually cooling throughout the year, payroll growth surged during the last few months. Combined with the uncertain impact from the incoming presidential administration’s policy proposals, the Fed signaled a less aggressive easing path than previously forecast. It now projects just two rate cuts for 2025, compared to the four projected at the September meeting.
While investor optimism remains high heading into 2025, the year is expected to bring significant changes. Proposals from the Trump administration for lower taxes, deregulation, tariffs, and strict immigration are likely to have a direct impact on the economy and further complicate the Fed’s efforts to lower interest rates. Furthermore, the themes that drove the equity market over the last two years may no longer have the same influence in the year ahead, with concentrated market leadership potentially giving way to broader participation across sectors. Given these factors, 2025 is shaping up to be a transitional year for both the economy and financial markets. In this evolving landscape, having a more balanced strategy may be a prudent approach.
We wish you all the best for 2025.