The fourth quarter of 2024 was not just a period of optimism and recovery but also one of reflection and recalibration. Investors and policymakers were presented with a complex set of variables: a resilient labor market, stubborn inflation, and a shifting geopolitical landscape, all of which contributed to a mixed bag of economic and market developments.
Earnings Resilience Meets Elevated Valuations
The third-quarter earnings momentum extended into October with corporations across multiple sectors surpassing consensus expectations. This resilience demonstrated that U.S. companies were not only adapting to a higher interest rate environment but thriving within it, particularly in industries powered by technological innovation and consumer spending. The tech sector continued to lead the charge, benefiting from artificial intelligence, automation, and cloud computing advancements. Meanwhile, consumer discretionary sectors gained traction as holiday shopping kicked off strongly, driven by robust online sales and pent-up demand.
Despite this strong performance, concerns about market valuations began to emerge. Analysts raised warnings about the “Magnificent 7” tech stocks (Apple, Microsoft, Tesla, Nvidia, Amazon, Meta, and Alphabet), whose soaring prices accounted for a disproportionate share of the S&P 500’s gains.
The Election Effect and Policy Expectations
As November arrived, earnings enthusiasm gave way to election fervor. The re-election of President Donald Trump reignited debates over fiscal and economic policy. Investors quickly priced in the potential for deregulation and corporate tax cuts, which were hallmarks of Trump’s campaign.
This wave of optimism particularly benefited the energy and financial sectors. Energy companies received more attention to their sector due to renewed optimism about energy infrastructure investment, while banks gained from expectations of a higher interest rate environment and further deregulation. However, some market participants remained cautious, pointing to uncertainties surrounding the implementation of such policies and the risk of geopolitical tensions impacting trade.
The Bond Market: Yield Curve Normalization and Persistent Challenges
While equity markets rode a wave of optimism, the bond market told a different story. The normalization of the 2s10s yield curve, which had been inverted for two years, was seen as a mixed signal. On one hand, the steepening curve was a positive sign, reflecting expectations for economic growth. On the other, it underscored the persistence of inflationary pressures and the market’s growing belief that the Federal Reserve’s job was far from over.
The Federal Reserve’s efforts to guide inflation toward its 2% target continued to dominate the narrative. Despite a series of rate hikes in 2022 and 2023, inflation remained above target, driven by wage growth and resilient consumer spending. Labor market reports in the fourth quarter painted a picture of economic strength, with unemployment holding near historic lows. However, these same conditions complicated the Fed’s task of containing inflation, as wage pressures and robust demand kept price levels elevated.
Breakeven inflation rates, which measure market expectations for inflation over the next five years, edged higher in Q4, reflecting skepticism about the Fed’s ability to achieve its target in the near term. This dynamic pushed the 10-year Treasury yield back above 4.6% in December.
A Year-End Rally Amid Persistent Risks
The final month of 2024 saw a year-end rally that solidified the stock market’s strong annual performance. The Nasdaq Composite breached the symbolic 20,000-point mark, and the S&P 500 closed the year up 25%. However, the bond market’s struggles served as a reminder of the challenges ahead. With inflation remaining stubbornly high and the labor market showing signs of cooling without faltering, the Federal Reserve faced a delicate balancing act. The specter of “higher for longer” interest rates loomed large, and market participants began to question the sustainability of the current economic expansion.
Concluding Thoughts and Implications for 2025
The fourth quarter of 2024 was emblematic of the broader themes that defined the year: resilience in the face of uncertainty, the dominance of technology and innovation, and the challenges posed by inflation and monetary/fiscal policy. While the stock market ended the year on a high note, supported by strong corporate performance and investor optimism, the bond market painted a more cautious picture, highlighting the complexities of navigating a high-rate, stubborn inflation environment.
As markets transition into 2025, investors face a range of questions. Will the Federal Reserve succeed in achieving a soft landing, or will the economy tip into recession as the full effects of tighter monetary policy are felt? Can corporate earnings growth continue at its current pace, or will high valuations prove unsustainable? And how will geopolitical tensions and global economic trends shape the investment landscape? Will fiscal policy play the role of dampener or accelerant for economic growth?
One thing is certain: the interplay between stocks and bonds, monetary and fiscal policy, and economic fundamentals will remain at the forefront of market dynamics. As always, we are committed to remaining vigilant, adaptable, and focused on the long term as we navigate the opportunities and challenges that lie ahead.
Source: FactSet
By J. Keith Buchanan, CFA, Senior Portfolio Manager
Originally published January 21, 2025
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