Markets in December
Markets in December
- Markets ended an otherwise great year down the last month of the year with the S&P 500 down 2.4%, the Dow down 5.1% and small cap stocks down 8.3%.
- The Fed cut rates for the third straight meeting to 4.25% - 4.5%. However, the summary of economic projections signaled that the Fed is concerned inflation hasn’t made much progress lately and they reduced the number of rates cuts expected in 2025 to two from the previous four penciled in. This caused interest rates to rise and the markets to sell off as some investors may have decided to lock in some gains after a great year.
- For the year the S&P 500 was up 25% setting 57 all-time highs. The largest companies continued their outperformance for the year, but the rest of the markets managed reasonable returns with the Dow up 15% and small caps up 11.5%. International markets didn’t fare quite as well with the EAFE up just 3.8% and emerging markets up 7.5%.
- This is the first time the S&P 500 has produced two consecutive years of 20%+ returns since 1997-1998.
- The rise in interest rates led to a 1.64% decline in the U.S Aggregate Bond Index leading to only a 1.25% gain on the year.
- Gold had its best year since 2010 up 27.5%.
- The Dollar had its best year since 2015 up 7%.
Why It Could Keep Going Higher
- The primary driver of U.S. economic growth is the U.S consumer and most Americans are fully employed and enjoyed significant wage gains over the past couple years. Most with low debt service costs.
- The new administration will likely reduce regulations and possibly lower taxes benefiting many industries and companies.
- Inflation continues to decelerate, albeit slowly and the Fed has initiated its monetary easing with a larger than expected 50 bps cut.
- Earnings are expected to grow 12% in Q4 with continued growth in 2025.
- Fiscal policy is still providing a tailwind to economic growth.
- Artificial Intelligence capex and promises of productivity gains are still in the early stages.
- There is a lot of cash still on the sidelines and investors may put it to work on the fear of missing out.
Biggest Risk
- Inflation and the Fed’s response to get it under control are still the biggest risks the economy faces currently. Fed policy impacts the economy with a significant lag so it is hard to determine what the future effects will be from the current rate hikes.
- Large scale deportation or greater than anticipated across the board tariffs could likely slow growth and increase inflation.
- Valuations are stretched and if earnings do not live up to expectations, a sell-off could occur.
- Employment data has been slowing with many businesses reporting that they do not anticipate increasing hiring.
- If the economy does begin to slow down, high wage costs may force employers to lay off workers to maintain profit margins.
- Additional bank failures and commercial real estate defaults.
- Further Geopolitical tensions.
What We Are Doing
The U.S. economy remains robust, with corporate earnings anticipated to grow steadily through 2025. The recent Republican sweep and the transition to a new administration are expected to foster a pro-business environment, potentially bolstering these growth estimates further.
In response to the election outcome, tactical adjustments were made to align with anticipated policy shifts favoring deregulation, lower taxes, and a more protectionist trade stance. Key portfolio changes included reducing an already underweight allocation to international equities and reallocating those proceeds to small and mid-cap U.S. equities, which stand to benefit from domestic-focused policies.
While the outlook is positive, there are risks worth monitoring. Potential challenges include large-scale deportations, trade wars, a slowing jobs market, and elevated market valuations with current price-to-earnings (P/E) ratios sitting at historically high levels.
Despite these risks, our current belief is that markets will continue to perform well into 2025. However, with limited room for further P/E expansion, we anticipate market growth to align more closely with historical averages, driven primarily by earnings growth rather than valuation increases.