Investors faced a lot of uncertainty in 2024 including elections, inflation, and geo-political conflict. All the same, equity markets continued to march higher, supported by strong economic growth. The US economy, as measured by GDP, grew a healthy 2.7% in the third quarter of 2024 versus a year ago (page 8). We believe this is a reasonable expectation for the full year 2024, putting the economy in a much healthier place going into 2025 than many perceive. Two-thirds of GDP is comprised of consumer spending (page 9), and the US consumer remains healthy for a variety of reasons. There have been 20 consecutive months of real wage growth, in which wages have increased faster than inflation on a year-over-year basis (page 10). While the unemployment rate has risen slightly to 4.2%, it remains low by historical standards, and we believe at a more sustainable level than the post-pandemic environment where it seemed that anyone could get a job. Immigration has also been a huge boost to the labor market, with the US Census estimating 2.8m people immigrated to the US from June 2023 to June 2024. The wealth effect has been another big tailwind to the consumer, with US household wealth increasing an estimated 11% in 2024, or by close to $15 trillion dollars (page 16). Inflation, while significantly lower than two years ago, appears to have stopped decelerating for the time being (page 18). This will remain a source of market anxiety in 2025, as a benign inflation picture remains the general catalyst for further Federal Reserve interest rate cuts. But a strong job market, paired with more workers, higher wages, and higher asset values, is a robust recipe for economic growth. Ultimately, this should result in strong corporate profits and higher corporate investment spending.
Against this economic backdrop, global equity market performance was strong in 2024. US Large Cap Equities, as measured by the S&P 500 Index, finished the year at +25% (page 20). From a fundamental perspective, higher corporate earnings and profitability continue to support higher prices. S&P 500 earnings are expected to have grown nearly 10% in 2024 (consensus is $238 per share), and nearly 15% in 2025 and 2026 (page 22). We believe that 15% earnings growth may be overly optimistic in an economy with 2-3% growth and 2% inflation, but this is nonetheless a testament to the resilience of US businesses. However, equity prices have risen faster than earnings, driving valuations higher (page 21)
The S&P 500’s 12-month forward price-to-earnings ratio is currently above 21x (its long-term average is 16-17x). Valuations are even more extreme in the largest 10 US companies, which now account for a record 39% of the S&P 500 index. These 10 companies trade at 30x forward earnings, while the other 490 remaining stocks trade at 18x (page 36). There is an argument to be made that the quality of these companies, as seen by their consistent secular earnings growth, higher return-on-equity, etc. warrants a higher multiple. But history tells us that eventually, incredibly high valuations and growth expectations likely lead to disappointments and devaluations. We believe this dynamic may not only create risks to traditional market cap indexing going forward but also create opportunities within the rest of the market. US Mid Cap Equities (S&P 400 Index) and US Small Cap Equities (S&P 600 Index) returned 14% and 9% respectively in 2024, failing yet again to keep pace with their larger counterparts. Small businesses are facing uncertainty from both a policy and regulatory standpoint (page 33), which has tempered future earnings expectations. Additionally, these smaller companies are typically more negatively impacted by higher interest rates than their larger counterparts. But at 16x forward earnings, paired with a strong backdrop for economic and corporate earnings growth, we believe these asset classes provide compelling opportunities for long-term investors. We remain Neutral weight to US Large, Mid and Small Cap Equities in our asset allocation models.
International equity markets reversed course in the fourth quarter, declining 8%, but held onto year-to-date gains. Non-US Developed Market Equities, as measured by the MSCI EAFE Index, finished the year +4% while Emerging Market Equities, as measured by the MSCI EM Index, finished the year +8%. President-elect Trump’s provocative rhetoric, particularly in relation to the imposition of trade tariffs on imported goods, is the most recent headwind faced by international equity markets. We do think it is likely the new administration will use tariffs to some degree, but we also see them as more of a negotiating tactic that will have a rather small impact on global growth. There is also an element of fatigue at play, as investors have watched US equity markets dominate their global counterparts for several years. All investors want to talk about, even those investors based overseas, is the S&P 500 Index. It is as if investing in Europe and the rest of the world seems irrelevant. We believe that is short-sighted, as these markets offer attractive investment opportunities for patient investors. These markets are trading at 12-14x forward earnings with a ~3% dividend yield. Yes, some of the valuation gap to US markets is deserved given lower earnings growth prospects and more cyclicality, as well as fewer technology-focused companies. But the valuation gap to US markets is the largest it has ever been (page 38). We remain Neutral on Non-US Developed Market Equities and Overweight Non-US Emerging Market Equities.
The Federal Reserve lowered interest rates at each of its last three meetings in 2024, with short-term interest rates currently at 4.25% to 4.5%. The Fed is now expected to lower rates another two times in 2025 (page 23). But Jerome Powell continues to walk a tightrope as he tries to ensure that the job market doesn’t slow too dramatically and inflation doesn’t increase. So far, the juggling act has gone pretty well. While all eyes have been on the Federal Reserve and short-term interest rates, long-term interest rates continue to play a leading role. Stronger-than-expected growth and continued concerns about the US government’s fiscal outlook have recently pushed long-term interest rates higher, the 10 Year US Treasury ended the year at 4.6%, approaching the 5% level it reached in October 2023 (page 24). With this volatility, we continued to take advantage of the opportunity, purchasing high quality bonds at attractive yields to lock in income in client portfolios. Our investment team has focused on generating consistent cash flow from the fixed income portion of client portfolios, whether through coupon income or consistent maturities. This cash flow is not only useful to manage client liquidity needs but also helps protect against the risk of rising interest rates as the cash can get reinvested at higher market rates. We remain Overweight to high quality Investment Grade credits, including municipals, Treasuries and corporates. While Non-Investment Grade bonds enjoyed another year of positive returns (+8% as measured by the Barclays High Yield index), credit spreads tightened to historically narrow levels (page 29). Even through the income is attractive on an absolute basis, we do not believe investors are being adequately compensated for taking excessive credit risk and remain Neutral to Strategic Bonds.
Long-time clients and readers of our Outlook know that we often provide statistics to support the futility of market timing and attempting, based on valuations or economic events, to be “in” or “out” of the market. The volatility that equity markets have experienced over the last three years certainly reinforced this thesis. Amidst the bear market in 2022, thanks to the Federal Reserve’s aggressive tightening, market pundits were all but guaranteeing a recession. Fast forward two years, and the US economy continues to grow, not to mention back-to-back years of 25%+ returns for the S&P 500 equity index. After the last several years of double- digit market returns (both positive and negative), market pundits are forecasting more “average” returns for equity markets in 2025 of 5-10%. Despite the S&P 500 delivering an average return of ~10% since 1926, these average returns are rarely achieved. The market has returned close to the average (between 8% and 12%) in only 6 of the past 100 years (page 39). Most years, the index’s return was outside of that range – often above or below by a wide margin – with no distinct pattern and little correlation to market forecasts and/or expected geopolitical impacts. While we remain cognizant of the risks on the horizon, we believe economic growth remains resilient and many asset classes remain attractively valued – a backdrop that should continue to help our clients meet their long-term goals.
