January 2025 Market Commentary

Market Recap

A Year of Impressive Market Gains

2024 proved to be an exceptional year for the U.S. stock market, with the S&P 500 index delivering a stellar performance. The index posted gains of over 25% for the year, marking its second consecutive year of returns exceeding 20%. This remarkable feat hasn’t been witnessed since the late 1990s, underscoring the strength and resilience of the market in the face of various economic challenges.

The Dow Jones Industrial Average also performed admirably, rising by 14.91% year to date. This broad-based rally extended beyond large-cap stocks, with the S&P MidCap 400 and Russell 2000 indices posting gains of 14.27% and 11.54%, respectively. These figures highlight the comprehensive nature of the market’s upward trajectory in 2024.

One of the most notable aspects of this year’s market performance was the frequency of new record highs. The S&P 500 set an impressive 57 all-time highs throughout the year, with new records being established in every month except April and August.¹ This consistent upward momentum reflects the strong underlying fundamentals and positive investor sentiment that characterized much of 2024.

The technology sector continued to be a significant driver of market gains, with companies like NVIDIA and Tesla reaching new heights. NVIDIA’s revenue skyrocketed to $91.2 billion in the nine months through October, more than doubling from the previous year, largely due to the surge in demand for AI-related technologies. Tesla’s stock price also hit record levels partly fueled by expectations of potential benefits from Elon Musk’s relationship with the newly elected administration.

However, it’s important to note that the market rally wasn’t solely dependent on the performance of Big Tech stocks. As the year progressed, there was a noticeable broadening of market participation, with sectors such as financials, industrials and consumer discretionary also contributing significantly to overall gains.

Economic Resilience and Growth

The U.S. economy demonstrated remarkable resilience throughout 2024, defying earlier predictions of a potential recession. Real gross domestic product (GDP) growth for the year is projected to reach a robust 2.9%, slightly surpassing the growth rate observed in 2023. This strong economic performance was underpinned by several key factors.

Consumer spending remained a crucial driver of economic growth, showing continued strength despite challenges such as hurricanes impacting large areas of the country. Black Friday and Cyber Monday sales reached record highs, and November retail sales were healthy, indicating robust consumer confidence and spending power. This resilience in household spending was fueled by strong wage growth, increased after-tax income, higher savings and improved consumer sentiment.

The labor market continued to exhibit strength, with the unemployment rate hovering around historically low levels. As of November, the unemployment rate stood at 4.2%, reflecting a tight job market that contributed to wage growth and overall economic stability. This low unemployment rate, combined with solid job creation, played a crucial role in sustaining consumer spending and economic growth.

Business investment also played a significant role in driving economic expansion. Nonresidential investment in machinery, equipment, intellectual property and infrastructure showed strength throughout the year. Government contributions from industrial policies and reshoring efforts further bolstered economic growth, reflecting a concerted effort to strengthen domestic production capabilities.

The housing market, while facing challenges from higher interest rates earlier in the year, showed signs of stabilization and even growth in some areas. The combination of strong wage growth and gradually moderating home prices helped to support activity in this crucial sector of the economy.

Looking ahead to 2025, while some moderation in growth is anticipated, the overall outlook remains positive. Forecasts suggest real GDP growth of about 2.2% for 2025, indicating a continued expansion, albeit at a more sustainable pace.

Federal Reserve’s Shift in Monetary Policy

2024 marked a significant shift in the Federal Reserve’s (Fed’s) monetary policy stance. After years of tightening to combat inflation, the Fed implemented three interest rate cuts throughout the year, signaling a new phase in its approach to managing the economy.

The first rate cut came in September, with the Federal Open Market Committee (FOMC) lowering the federal funds rate by 50 basis points to a range of 4.75% to 5%. This move was seen as a decisive step to support economic growth and stabilize a slowing labor market. The Fed’s decision was influenced by progress on its dual mandate of maximum employment and price stability.

Following the September cut, the Fed implemented two additional 25-basis-point cuts in November and December, bringing the federal funds rate to a range of 4.25% to 4.5% by the end of the year. These cuts reflected the Fed’s assessment that the risks to achieving its employment and inflation goals were moving into better balance.

In its communications, the Fed emphasized that while inflation remained above its 2% target, it had eased substantially over the past year without a significant increase in unemployment. This “soft landing” scenario, where inflation is brought under control without triggering a recession, was a key factor in the Fed’s decision to begin easing monetary policy.

The Fed’s projections, released in December, indicated expectations for further rate cuts in 2025, though fewer than initially anticipated. The median FOMC participant penciled in 100 basis points of cuts for 2025, followed by 50 basis points more in 2026, bringing the projected terminal rate to 2.9%.

Broadening Market Rally

While the early part of 2024 saw the stock market rally largely driven by a handful of mega-cap technology stocks, often referred to as the “Magnificent 7,” the latter part of the year witnessed a significant broadening of market participation.

This shift was evident in the performance of small-cap stocks, which saw substantial gains, particularly in the fourth quarter. The Russell 2000 Index, a benchmark for small-cap stocks, rose nearly 9% in the third quarter and finished higher by over 11.54% year to date. This outperformance of small caps relative to their large-cap counterparts signaled growing investor confidence in the broader economy and a willingness to take on more risk.

The broadening rally was also reflected in sector performance. While technology continued to be a strong performer, other sectors such as financials, industrials and consumer discretionary saw increased investor interest. This rotation was partly driven by expectations of economic policies following the election, with sectors like financials benefiting from prospects of deregulation and increased M&A activity.

The shift toward a more balanced market was welcomed by many investors and analysts, as it suggested a healthier and more sustainable bull market. A broader rally typically indicates that the economic recovery is more widespread and not overly dependent on a small number of large companies.

However, it’s worth noting that despite this broadening, the largest technology companies continued to exert significant influence on overall market performance. The Magnificent 7′ stocks still accounted for a substantial portion of the S&P 500’s gains, albeit less dramatically than in the first half of the year.

Inflation’s Downward Trend

Throughout 2024, inflation continued its downward trajectory, moving closer to the Fed’s 2% target. This cooling of inflationary pressures was a key factor in its decision to begin easing monetary policy and contributed significantly to positive market sentiment.

As of November 2024, the CPI stood at 2.7% year over year, up slightly from 2.6% in October but still significantly lower than the peak levels seen in 2022. This moderate uptick was partly influenced by low base effects from the previous year and did not derail the overall downward trend in inflation.

The Personal Consumption Expenditures (PCE) price index, the Fed’s preferred measure of inflation, showed similar progress. Core PCE inflation, which excludes volatile food and energy prices, stood at 2.8% year over year in January, with a further decline to 2.5% on a six-month annualized basis.

Several factors contributed to the moderation in inflation:

1. Supply chain improvements: The resolution of many supply chain disruptions that had driven up prices in previous years helped to ease inflationary pressures.
2. Housing market stabilization: While shelter costs remained a significant contributor to inflation, the rate of increase began to moderate as the year progressed.
3. Energy prices: Energy costs continued to decline, with gasoline prices falling 8.1% year over year in November.
4. Monetary policy effects: The lagged effects of the Fed’s earlier interest rate hikes continued to work through the economy, helping to cool demand-driven inflation.

Looking ahead, many economists and the Federal Reserve projected inflation to continue its gradual decline. Morningstar, for instance, forecast PCE inflation to average 2.4% in 2024 and then fall further to an average of 1.8% starting in 2025 through 2028. This outlook for sustained moderation in inflation played a crucial role in shaping market expectations and Fed policy decisions throughout the year.

In conclusion, 2024 proved to be a year of significant positive developments for the U.S. economy and financial markets. The combination of strong economic growth, a shift toward more accommodative monetary policy, broadening market participation and moderating inflation created a favorable environment for investors. While challenges and uncertainties remain, particularly regarding the sustainability of economic growth and the long-term impacts of policy decisions, the overall trajectory as of the end of 2024 pointed toward continued stability and potential for further gains in the coming year.