“Predicting rain doesn’t count, building the ark does.” – Warren Buffett
“Have an opinion on what the market should do but don’t decide what the market will do.” – Bernard Baruch
We believe “a good year that ended on a sour note” is probably the best way to describe 2024. For equity investors, all the major US indexes performed exceptionally well except for the Small Cap S&P 600, which we would still describe as having a good year. International equities, once again, lagged their US-based counterparts. Bonds, commodities, and the US dollar all posted positive 2024 returns.
All data as of 01/02/2025, Source: Wells Fargo Investment Institute. An index is not managed and not available for direct investment. Past performance is not a guarantee of future results. [Wells Fargo Investment Institute, Inc. is a registered investment advisor and wholly-owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company.]
As stated above, we would describe the stock market indexes in 2024 as a weak finish to a strong year. This can be interpreted in several ways, depending on the time frame you use as your guide. For the day trader with a bullish bias, December was rough sledding. For the investor who thinks in weeks and months, December’s performance could be causing some rethinking of strategy. At Magellan Financial we take a different approach. When we think and talk about the markets – stock, bonds, commodities, currencies – we like to expand our lenses to get a broader perspective on what’s happening. This is not just looking at the performance of the markets, but also considering fundamentals like the economic background and company earnings.
Fundamentally, 2024 was what we would consider a great year. S&P 500 earnings were strong, as was US GDP. The Wells Fargo Investment Institute’s final 2024 earnings expectation for the S&P 500 is $275 while 2024 US GDP estimates range between 2.4% and 2.7%.(1)(2)
The S&P 500 enters 2025 after a very good five-year run. Chart #1 is the S&P 500 over the previous 5-year period. From point to point, the performance has been impressive. Between January 1, 2020 and the end of 2024, however, the path higher hasn’t been smooth. Specifically, the short and steep 2020 bear market which coincided with Covid-19, and the bear market of 2022 were a challenge.
Chart #1: www.stockcharts.com Data 01/01/20 – 01/09/25 as of 01/09/25. An index is not managed and not available for direct investment. MA 50 = 50-day moving average MA 200= 200-day moving average. Past performance is not a guarantee of future results.
Three Themes for 2025
As we say every year, we are not in the game of placing a price target on the stock market indexes and taking a guess at where bond yields will be a year from now. Useless in our opinion, and a fool’s game. Even if we could predict the expected and unexpected happenings in 2025, we would then have to know how the markets would react to the news. For those interested in the S&P 500 price targets some of the major investment houses have predicted, please see our December Market Report.
What we do find useful, however, is to think through the big picture of how the world is working. The result is a number of themes we believe are useful guides to understanding what will drive the markets over the short, intermediate, and long term. For 2024 we had 3 themes that we were focused on; this year we have another three.
Theme #1: US Economy Remains Strong, Leading the Global Economy
The global economy has shown resilience following the shocks of the pandemic, reopening, and inflation/interest rate fluctuations. From our point of view, two significant challenges persist: Germany’s weak economy and China’s economic downtrend is worsening. According to the European Commission (EU), GDP growth in the third largest economy will end 2024 at a negative 0.1% and only rebound to an expected 2025 growth rate of 0.7%.(3) According to the US State Department Chinese factory output, consumption, and investment all slowed more than expected, with the unemployment rate increasing.(4) This expected weakness in the second and third largest global economies leads us to the conclusion that the global outlook for 2025 hinges on the performance of the US economy, which remains the largest global economy and key demand driver.
Magellan’s Take: The US economy’s robustness is vital for global economic stability. The 2025 outlook for the US economy depends on both organic macroeconomic dynamics and policy changes. The UN report highlights that while the US economy is expected to moderate from 2.8% growth last year to 1.9% in 2025, it remains a critical factor for global economic health. Should the US economy falter, the repercussions would be felt worldwide, given its significant role in global demand.(5)
Theme #2: Interest Rates Higher for Longer, Steepening Yield Curve
In 2025, we expect the US Treasury interest rates to remain higher than many anticipate due to several key factors. Firstly, inflation is projected to remain “sticky,” meaning it will continue to persist at levels above the Federal Reserve’s target of 2%. Despite cooling from its peak in 2022, inflation is forecasted to settle around 2.5% to 2.6% over the next year. The possibility of additional tariffs on imported goods could exasperate the issue. Persistent inflationary pressure necessitates higher interest rates to curb demand and stabilize prices.
Secondly, as stated in our first theme, the US economy is anticipated to continue its positive growth trajectory. Strong economic indicators, such as robust consumer spending and a stable labor market, contribute to this outlook. The Federal Reserve’s cautious approach to interest rate cuts reflects concerns about overheating the economy, which could lead to further inflationary pressures.
Lastly, after years of short-term interest rates persistently higher than long-term rates, the yield curve has been steepening and, we believe, is likely to continue to steepen in 2025. This is not necessarily a bad thing. A steepening yield curve typically indicates expectations of higher future interest rates and economic growth.(6) This trend is driven by the market’s anticipation of continued economic expansion and the Federal Reserve’s commitment to maintaining higher rates to manage inflation.
Magellan’s Take: The combination of sticky inflation, sustained economic growth, and a steepening yield curve suggests that US Treasury interest rates will remain elevated throughout 2025 and that future short-term interest rate cuts by the Federal Reserve Board of Governors (The Fed) could be in jeopardy. Higher long-term rates and/or a shortening of the rate-cutting cycle could become a negative factor for the stock market and the general economy later this year. Funding costs for corporations in the public markets would likely increase as well.
Chart #2: www.stockcharts.com Data 01/01/22 – 12/31/24 as of 01/09/25. An index is not managed and not available for direct investment. MA 50 = 50-day moving average MA 200= 200-day moving average. Past performance is not a guarantee of future results.
Theme #3: Earnings Growth Outpaces Market Index Performance
Historically, there have been periods where individual corporate earnings have shown remarkable growth, diverging from broader market indices. A notable example of this occurred from 2003 to 2007, a time marked by significant corporate earnings expansion which, in many cases, surpassed the growth of market indices. In our opinion, the outlook for 2025 indicates a similar situation could be forming in the stock market.
During the 2003-2007 period, there were many companies with business models that were growing at a rapid pace. Many of those same companies, however, had stock valuations that were well above historical norms. Over these five years, these companies, and the stock market overall, continued to grow earnings at a faster pace than their stock prices increased.
Shifting to 2025, many companies continue to be well-positioned to leverage advancements in technology, changing government policy, and shifting consumer behaviors to drive earnings growth. Many of these same companies, however, have seen their stock prices increase much faster than their earnings, driving the overall market valuations to relatively high levels. After a decade of expanding stock prices, 2025 could be the year that the growth in stock prices does not keep up with company earnings.
Magellan’s Take: The end of expanding valuations does not necessarily mean the bull market that began in 2013 is over. If, however, we are correct that valuation expansion is over for this cycle, and earnings will continue to grow, stock market indexes can continue to trend higher, just at a slower pace than they have in the recent past.
Putting It All Together
Over the years we have had many discussions with clients and prospects about the markets. As a rule, we always have an opinion about where the stock market is, where we think it is likely headed, and what factors we consider the most important. There are two points that we believe are critical to understanding our analysis:
- We are never under the delusion that our opinions can or will dictate what the markets will do.
- Any opinion we have is one we truly believe in but is lightly held.
Put another way, the markets do not care what we think, and, even if it does care, we will change those opinions when the data in front of us leads us to a different (even contrary) opinion.
With that said, while we believe that all three of our themes are important, interest rate policy and the yield curve will be the most impactful. If, as we believe, the Fed’s rate-cutting cycle is either completed or will be in the coming months, it has the potential to become a problem. The same for the yield curve – if long-term rates continue to go higher while short-term rates remain around current levels problems could present themselves.
Several economic sectors and subsectors are heavily impacted by interest rates. Capital-intensive industries like utilities and REITs will face higher capital costs in a higher-for-longer scenario. Home builders would likely be impacted if the cost of a 30-year mortgage moved back up to the 8% level.
We also recognize that inflation could become an issue in the next twelve months. The CRB Commodities Index was up 12.47% in 2024 and could be heading back to the 2022 peak of 330. With 39% of the index allocated to energy and 41% to agriculture,(7) we would expect higher prices at the gas pump along with food prices at the supermarket if the index continues higher. With personal consumption expenditures representing 68% of the US economy,(8) higher food and energy costs could have a negative impact on the economy and corporate earnings.
At the start of the new year, we remain positive about the economy and cautiously optimistic about the stock market. Corporate earnings should remain robust. After two years of positive growth for equities, our expectation is for more market volatility than in the recent past, but positive returns for the year. If something changes with our three themes in the coming months, so will our expectations.
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Sources:
- Economic Outlook U.S. Q4 2024: Growth And Rates Start Shifting To Neutral | S&P Global Ratings
- The Fed – December 18, 2024: FOMC Projections materials, accessible version
- Economic forecast for Germany – European Commission
- Global Implications of China’s Economic Expansion – United States Department of State
- UN Predicts World Economic Growth to Remain at 2.8% in 2025
- For a better understanding of the yield curve: Yield Curve: What It Is and How to Use It
- Commodity Research Bureau Index (CRBI): Definition and Weightings
- Consumer Spending | U.S. Bank
On behalf of Magellan Financial, we would like to thank you for taking the time out of your busy day to take in our thoughts and opinions. If you found this helpful, please forward it to others. If you have any questions on the materials presented, would like to be added to our email list, or would like our help with your investments, we can be contacted at 610-437-5650 or via email.
Wells Fargo Advisors Financial Network did not assist in the preparation of this report, and its accuracy and completeness are not guaranteed. The opinions expressed in this report are those of the author(s) and are not necessarily those of Wells Fargo Advisors Financial Network or its affiliates. The material has been prepared or is distributed solely for information purposes and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Additional information is available upon request.
Asset allocation and diversification are investment methods used to help manage risk. They do not guarantee investment returns or eliminate risk of loss including in a declining market.All investing involves risks including the possible loss of principal invested. Past performance is not a guarantee of future results.
Index returns are not fund returns. An index is unmanaged and not available for investment.
Dow Jones Industrial Average: The Dow Jones Industrial Average is a price-weighted index of 30 “blue-chip” industrial U.S. stocks.
S&P 500 Index: The S&P 500 Index consists of 500 stocks chosen for market size, liquidity, and industry group representation. It is a market value weighted index with each stock’s weight in the Index proportionate to its market value.
S&P Midcap 400 Index: The S&P Midcap 400 Index is a capitalization-weighted index measuring the performance of the mid-range sector of the U.S. stock market, and represents approximately 7% of the total market value of U.S. equities. Companies in the Index fall between the S&P 500 Index and the S&P SmallCap 600 Index in size: between $1-4 billion.
S&P Small-Cap 600 Index: The S&P SmallCap 600 Index consists of 600 domestic stocks chosen for market size, liquidity (bid-asked spread, ownership, share turnover and number of no trade days) and industry group representation. It is a market value-weighted index (stock price times the number of shares outstanding), with each stock’s weight in the index proportionate to its market value.
MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed, or produced by MSCI.
MSCI World Index: The MSCI World Index is a free float-adjusted market capitalization index that is designed to measure global developed market equity performance.
MSCI EAFE® Index: The MSCI EAFE Index is designed to represent the performance of large and mid-cap securities across 21 developed markets, including countries in Europe, Australasia and the Far East, excluding the U.S. and Canada.
MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets.
The CRB (Commodity Research Bureau) Index measures the overall direction of commodity sectors. The CRB was designed to isolate and reveal the directional movement of prices in overall commodities trades.
Bloomberg Barclays U.S. Aggregate Bond Index: Bloomberg Barclays U.S. Aggregate Bond Index is a broad-based measure of the investment grade, US dollar-denominated, fixed-rate taxable bond market.
NASDAQ Composite Index: The NASDAQ Composite Index measures the market value of all domestic and foreign common stocks, representing a wide array of more than 5,000 companies, listed on the NASDAQ Stock Market.
Russell 2000® Index: The Russell 2000® Index measures the performance of the 2,000 smallest companies in the Russell 3000® Index, which represents.
U.S. Dollar Index (USDX) measures the value of the U.S. dollar relative to majority of its most significant trading partners. The index is similar to other trade-weighted indexes, which also use the exchange rates from the same major currencies.
Technical analysis is only one form of analysis. Investors should also consider the merits of Fundamental and Quantitative analysis when making investment decision. Technical analysis is based on the study of historical price movements and past trend patterns. There is no assurance that these movements or trends can or will be duplicated in the future.
Stocks offer long-term growth potential, but may fluctuate more and provide less current income than other investments. An investment in the stock market should be made with an understanding of the risks associated with common stocks, including market fluctuations.
Investing in foreign securities presents certain risks not associated with domestic investments, such as currency fluctuation, political and economic instability, and different accounting standards. This may result in greater share price volatility.
Investments in fixed-income securities are subject to market, interest rate, credit and other risks. Bond prices fluctuate inversely to changes in interest rates. Therefore, a general rise in interest rates can result in the decline of the bond’s price. Credit risk is the risk that the issuer will default on payments of interest and/or principal. The risk is heightened in lower rate bonds. If sold prior to maturity, fixed income securities are subject to market risk. All fixed income investments may be worth less than their original cost upon redemption or maturity.
Investing in commodities is not suitable for all investors. The commodities markets are considered speculative, carry substantial risks, and have experienced periods of extreme volatility. Investments in commodities may be affected by changes in overall market movements, commodity index volatility, changes in interest rates or factors affecting a particular industry or commodity. Exposure to the commodities markets may subject an investment to greater share price volatility than an investment in traditional equity or debt securities. The prices of various commodities may fluctuate based on numerous factors including changes in supply and demand relationships, weather and acts of nature, agricultural conditions, international trade conditions, fiscal monetary and exchange control programs, domestic and foreign political and economic events and policies, and changes in interest rates or sectors affecting a particular industry or commodity. Products that invest in commodities may employ more complex strategies which may expose investors to additional risks, including futures roll yield risk.
Robert I. Cahill, Partner Rob.Cahill@wfafinet.
Jonathan D. Soden, Managing Partner Jon.Soden@wfafinet.com
Robert Sweeney, Financial Advisor Bob.Sweeney@wfafinet.com
Jay Knight, Senior Account Administrator Jay.Knight@wfafinet.com