Newsletter Snapshot: Overall economic growth remained strong in 2024 while the Federal Reserve cut interest rates by 1% based on lower inflation. More of the same is generally expected for the economy in 2025. Policy changes and above-average valuations add a degree of uncertainty for markets.
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Aided by a strong U.S. economy, overall market returns were very solid in 2024. The S&P 500 gained over 25% for the second year in a row. Big tech companies once again led the way. Bonds and international stocks declined in the fourth quarter, but still finished positive for the year.
Economy and Inflation
Throughout 2024 we monitored JP Morgan’s Economist Dr. David Kelly’s “2-0-2-4” forecast: 2% economic growth, 0 - no recession, a return to 2% inflation, and a 4% unemployment rate. The charts below show economic growth and inflation were both a bit higher than expected with no sign of recession and 4% unemployment. In January 2025, Dr. Kelly said he is "tempted" to use the same 2-0-2-4 forecast again, though he was less confident because of greater policy uncertainty in Washington.
Magnificent Seven
The chart on the right shows the Magnificent Seven are having substantial influence on S&P 500 returns. Fortunately, the "Magnificent Seven" have gotten their name by producing magnificent returns in three of the last four years. Unlike some of the dot-com era stocks, the Magnificent Seven gains have been strong earnings and healthy balance sheets. Calendar year 2022 is a reminder that concentration risk can add volatility to the downside as well. According to FactSet, earnings forecasts for 2025 remain healthy, however investors should be cognizant of equity valuations. Valuations measured by price-to-forward earnings sit near 20-year highs for the S&P 500, with Large Growth contributing the most to high valuations. With current price-to-earnings multiples above historical averages, there is limited room for further multiple expansion. Moderating expectations for equity returns may be prudent. David Giroux, Chief Investment Officer at T.Rowe Price, was quoted in Barron’s (Jan 12, 2025), “Based on our company-by-company analysis of where stocks will trade by 2030, our five-year-forward total-return estimate for the S&P 500 is less than 5% a year." These observations are a reminder to maintain a balanced equity portfolio that aligns with your investment objective.
International Equities
Equity markets outside the U.S. last year faced numerous challenges; one of the more broad-based challenges was the strength of the U.S. dollar. A strengthening U.S. dollar acts as a headwind for international stock returns. In 2024 the dollar appreciated by roughly 7%, resulting in a 7% drag on the return of the MSCI EAFE Index when converted into U.S. dollars. This headwind can turn to a tailwind should the dollar soften in the future. Emerging markets present a mixed picture. China's modest recovery, aided by policy stimulus, is tempered by structural challenges in the property sector and weaker consumer confidence. Conversely, India has shown strong domestic consumption, demographic advantages, and significant infrastructure investments. We believe valuations reflect the current fundamentals, given geopolitical tensions and regional risks persist. Patient investors should experience the benefits of maintaining diversification in due time.
Fixed Income Update
With The Federal Reserve cutting short-term interest rates, yields on the short-term treasuries are yielding less then longer-term treasuries. This is the norm. 2024 marked the end of the inverted treasury yield curve which lasted 793 days, one of the longest inversion periods on record. An inverted yield curve occurs when short-term treasuries yield more then long-term treasuries. What is interesting is that while the cutting cycle has begun, longer-term yields have actually moved higher. This occurrence is an important reminder. The Federal Reserve controls short-term interest rates but investors and market participants generally determine longer-term interest rates. Longer-term yields moving higher can be attributed to growth expectations improving, investors demanding more yield given the added volatility and rate uncertainty, and inflation expectations moving higher. The chart below depicts The Federal Reserve's rate policy overtime. Expectations have shifted over the past year, and today reflect a period more akin to the 1990's an era where The Federal Reserve achieved a soft landing.
Conclusion
A repeat of the 2-0-2-4 type of economy should be a good environment for both stock and bond returns, but policy changes in Washington add a degree of uncertainty to the outlook. For example, President Trump may announce tariffs at a certain level for negotiating purposes before enacting them at a lower level. In general, most economists expect Trump's policies to extend the recent trend of slightly higher growth and inflation. More persistent inflation may also alter the Federal Reserve's path for interest rate cuts. As time goes on, keep in mind that even good markets have an occasional setback. Since 1928, the S&P 500 averages 3.5 pull backs of 5% or more every year. (NDR, 1.22.25) Remember to invest in a portfolio you can stick with no matter what tomorrow's headlines may read.
In closing, we always encourage investors to think long-term. The chart to the left shows most categories are still up over the last three years despite the downturn in 2022. For those of you who wish to revisit your portfolio, please contact us at 800-242-4735. For more on the markets, click on the resources tab on our website www.spectruminvestor.com.
Spectrum Investment Advisors 6329 W. Mequon Road Mequon, WI 53092 262-238-4010 | www.spectruminvestor.com
Data as of 12/31/24 unless otherwise noted. The Dow Jones Industrial Average is comprised of 30 stocks that are major factors in their industries and widely held by individuals and institutional investors. The S&P 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. The NASDAQ Composite Index measures all NASDAQ domestic and non-U.S. based common stocks listed on The NASDAQ Stock Market. Barrel of Oil: West Texas Intermediate. Inflation Rate: CPI. The market value, the last sale price multiplied by total shares outstanding, is calculated throughout the trading day, and is related to the total value of the Index. Indices cannot be invested into directly. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.
Benchmark Disclosures: Morningstar Category Averages: Morningstar classifies mutual funds into peer groups based on their holdings. The Category Average calculates the average return of mutual funds that fall within the category during the given time period. The following indexes and their definitions provide an approximate description of the type of investments held by mutual funds in each respective Morningstar Category. One cannot invest directly in an index or category average. Index returns do not reflect trading, advisory and other fees and expenses which are incurred in your actual investment accounts and would reduce your returns. Intermediate-Term Bonds: Bloomberg US Agg Bond Index–Measures the performance of investment grade, US dollar-denominated, fixed-rate taxable bond market, including Treasuries, government-related and corporate securities, MBS, ABS and CMBS. Allocation 50%-70% Equity–These funds invest in both stocks and bonds and maintain a relatively higher position in stocks. These funds typically have 50%-70% of assets in equities and the remainder in fixed income and cash. Large Cap Value: S&P 500 Value Index–Measures the performance of value stocks of the S&P 500 index by dividing into growth and value segments by using three factors: sales growth, the ratio of earnings change to price and momentum. Large Cap Blend: S&P 500 Index–A market capitalization-weighted index composed of the 500 most widely held stocks whose assets and/or revenue are based in the US. Large Cap Growth: S&P 500 Growth Index–Measures the performance of growth stocks drawn from the S&P 500 index by dividing it into growth and value segments by using three factors: sales growth, the ratio of earnings change to price and momentum. Mid Cap Value/Mid Cap Growth: S&P MidCap 400 Index–A market cap weighted index that covers the complete market cap for the S&P 400 Index. All S&P 400 index stocks are represented in both and/or each Growth and Value index. Mid Cap Blend: S&P MidCap 400 Index–Measures the performance of mid-sized US companies, reflecting the distinctive risk and return characteristics of this market segment. Small Cap Value: Russell 2000 Value Index–Measures the performance of small-cap value segment of Russell 2000 companies with lower price-to-book ratios and lower forecasted growth values. Small Cap Blend: Russell 2000 Index–Measures the performance of the small-cap segment of the US equity universe. It includes approximately 2000 of the smallest securities based on a combination of their market cap and current index membership. Foreign Large Cap Blend: MSCI EAFE NR Index–This Europe, Australasia, and Far East index is a market-capitalization-weighted index of 21 non-US, developed country indexes. Small Cap Growth: Russell 2000 Growth Index–Measures the performance of small-cap growth segment of Russell 2000 companies with higher price-to-value ratios and higher forecasted growth values. Real Estate: DJ US Select REIT Index–Measures the performance of publicly traded real estate trusts (REITs) and REIT-like securities to serve as proxy for direct real estate investment. Natural Resources: S&P North American Natural Resources Index– Measures the performance of US traded securities classified by the Global Industry Classification Standard (GICS) as energy and materials excluding the chemicals industry and steel but including energy companies, forestry services, producers of pulp and paper and plantations. Past performance is no guarantee of future results. This report is for informational purposes only and should not be construed as a recommendation or solicitation to buy or sell any security, policy or investment. PE Ratio is the measure of the share price relative to the annual net income earned by the firm per share.