Like most investors, we have been impressed by the enduring strength of the U.S. economy and the overall performance of the market. Financial assets delivered another superb year in 2024, driven by resilient economic growth, declining inflation, and enthusiasm surrounding advances in artificial intelligence. All major equity indices finished last year in positive territory, with the S&P 500 index advancing 25%, marking its best back-to-back yearly performance since 1998. We enter 2025 on a constructive note with a growing economy and positive outlook for corporate profits, but also with an appreciation for the risks-to-returns on the heels of two years of substantial gains in the market.
The overall health of the economy, inflation, and the Federal Reserve’s policy actions remain front and center for investors in 2025. In addition, markets will be weighing the short-term and long-term policy implications of a new Presidential administration. As we begin the New Year, we frame our bullish and bearish thoughts on the current economic climate and market environment while taking time to underscore our core investment principles, which are designed to help clients weather a range of market conditions.
The bull case for stocks is based upon (1) continued economic growth while keeping inflation in check, (2) continued strength and resilience of consumer and corporate balance sheets, and (3) a widening of market breadth outside of mega-cap technology stocks.
With inflation subsiding and the Fed in an easing mode overall, economic growth seems poised to persist with limited recession risk on the immediate horizon. Key to the bull case is the continued strength of the current economic environment without reigniting inflation. To date, consumers and businesses have adeptly navigated a higher interest rate environment. Corporate earnings are expected to grow by 13% this year as cost pressures and revenue growth have stabilized. With corporate balance sheets in good health and with ready access to capital, companies are well positioned to reinvest in their businesses, return capital to shareholders, and participate in merger and acquisition activity this year. On the consumer side, consumption remains the biggest single driver of the economy (contributing almost 70% of nominal GDP) and is benefitting from a tight labor market as well as improving household balance sheets. Although personal saving rates have fallen and credit card balances have risen, consumers, overall, have been a major source of stability for America’s consumption-based economy.
The bull market over the past two years has been disproportionately led by mega-cap technology shares, which have benefitted from excitement regarding artificial intelligence, robust earnings growth, and multiple expansion. In our view, continuation of the bull market may largely depend on other sectors leading the next move even higher.
The bear case rests on (1) the economy slowing due to higher interest rates, (2) uncertainty regarding the impact of fiscal and monetary policy decisions, and (3) pressure on valuation levels, if earnings growth disappoints.
Business confidence has risen in the aftermath of the Presidential election in light of overall expectations that the new administration will favor pro-growth policies, lower corporate taxes, and roll back regulation. However, this economic outlook is not without risks. Even though the Fed has lowered its benchmark interest rate by one percentage point since September, intermediate and long-term yields have moved higher. Of note, key consumer borrowing rates – including the 30-year mortgage rate – hover near 7%, and the prime rate is 7.5%, which if sustained over time, could crimp growth. In addition, while prospects for additional monetary accommodation and a more business-friendly environment are certainly welcome, there is always a risk that policy actions will miss their mark. Stricter trade policies and a hawkish Fed are two of the risks that could potentially unsettle markets in 2025 and beyond.
As we enter the third year of the current bull market, market valuation levels are trading above their long-term historical average. Mega-cap companies have led the way, with the top 10 largest stocks in the S&P 500 trading at 30 times forward earnings while the remaining 490 stocks trade at a more reasonable 18 times forward earnings. Elevated valuations may make stocks more vulnerable to a slowdown in earnings or weakening economic data.
At The Fiduciary Group, we continue to focus on constructing portfolios that enable our clients to maintain their asset allocations throughout the market cycle, especially during the stressful periods when it matters most. In other words, we accept the fact that we cannot predict volatility or periodic downturns in the market. Instead, we devote our time and attention to preparing clients to weather changing market conditions, including bull as well as bear periods, and to accomplish financial goals through a diversified, long-term investment strategy.
We believe in the importance of strategic asset allocation and diversification, so that clients’ investment strategies are aligned with their risk tolerance as well as their future cash needs. We focus on each client’s ability to bear risk and capacity to withstand the swings that accompany changes in market values. Individual client circumstances always inform our investment decisions, and we understand that every client situation is unique.
Ultimately, our goal is to intelligently balance the mix of stocks and bonds to adequately capture the benefits they provide for investors while also remaining cognizant of their intrinsic limitations. Our objective is to set asset allocations so clients will have the conviction to stay invested throughout the market cycle and reap the benefits of long-term compounding over time.
As investors, our greatest strength lies in how we choose to react to market volatility. We affirm our longstanding belief that a balanced, diversified, strategic approach helps clients stay invested throughout a range of market and macroeconomic cycles and puts them in the best position to achieve returns and to accomplish their goals over the long run.
Please feel free to reach out to us with any questions. As always, we greatly appreciate the trust our clients place in us.