2024 was a year that mostly outpaced expectations. Coming into the year, the consensus on the economy was that U.S. economic growth would normalize and underperform the long-term average of 2%.¹ However, the U.S. economy is now expected to grow by 2.7% in 2024, far exceeding initial projections.² The primary drivers of this growth were increased government expenditure, AI-driven private investment and robust consumer spending.³

The same trend was observed in the stock market. Top Wall Street strategists had predicted a modest 1.9% rate of return on average for the S&P 500 in 2024, with the most bearish outlook coming from JP Morgan Chase, the largest bank in the world, forecasting negative returns of 12%.⁴ Contrary to these predictions, the S&P 500 delivered a blockbuster year, returning approximately 25%.⁵ Notably, risk levels, measured through standard deviation, remained below 11% for the year. The average since 1993 has been 15% standard deviation.⁶ U.S. exceptionalism continued to shine in 2024, with economic growth significantly outpacing that of other G7 countries since the pandemic.⁷ Bonds had another challenging year, with the Aggregate Bond Index (AGG) returning just 1.3%. Meanwhile, international markets also struggled, with their index yielding a modest return of 4.72%.⁸

Inflation showed improvement in 2024, declining from 3.1% to 2.7%, though it remained above the Federal Reserve’s 2% target.⁹ The unemployment rate rose from 3.7% to 4.2%, yet it stayed below its long-term average, reflecting a robust labor market overall.¹⁰ The Federal Reserve cut interest rates by 100 basis points during the year, but the 10-year Treasury yield ended higher, rising from 3.86% to 4.57%.^{10, 11} Encouragingly, wages have outpaced inflation on a year-over-year basis for 19 consecutive months.¹⁴ Overall, economic risk remained low, as indicated by tight spreads in investment-grade (IG) and high-yield (HY) bonds.¹⁵

All years carry an element of uncertainty, but we believe 2025 is slightly more uncertain than usual. The new administration has provided limited clarity on the direction of the economy and other policies. Moreover, while 2024 was a remarkably strong year for the S&P 500, the returns were not evenly distributed. Three main factors drove much of the 2024 gains in our opinion: 1) valuation expansion, 2) increased government spending and large deficits, and 3) massive outperformance of mega cap companies, especially the Mag7. The S&P 500 is now richly valued, and history suggests that elevated valuations often lead to subdued returns in the future. The current forward price-to-earnings (P/E) ratio for the S&P 500 stands at about 21.5, compared to a 30-year average of less than 17.^16,17

Another issue is the index’s concentration in mega-cap stocks. The top 10 companies in the S&P 500 now account for approximately 40% of the index, compared to just 18% in 2015.^18,19 Additionally, government spending part of GDP remains uncertain. The new administration has pledged fiscal discipline and is creating the Department of Government Efficiency (DOGE) to address deficits.¹⁹ While reducing deficits is beneficial in the long term, it could create short- to medium-term pain.

Furthermore, we are also uncomfortable with widespread optimism from Wall Street and households. Analysts expect 14.8% earnings growth for 2025 vs 10% in 2024. Profit margins are expected to hit the highest level in modern history.²⁰ Top Wallstreet strategists who expected 1.9% return for 2024 expect positive returns for 2025 and the percentage of Americans expecting the stock market to rise in 2025 has reached an all-time high.^21,23

Our expectations for 2025 are mixed. While we do not foresee a significant rise in the unemployment rate, we anticipate overall market volatility will be higher in 2025 compared to 2024. The equity market could face a challenging environment, as current market conditions suggest that expectations for earnings growth and profit margins are overly optimistic.

In this context, it is crucial to remain invested in line with your risk tolerance. Diversifying across bonds and stocks, combined with a tactical managementapproach, can help navigate the uncertainties ahead.

Sources:
1. Leading Experts Weigh In On Growing The U.S. Economy In 2024. https://www.forbes.com/sites/ankitmishra/2023/12/18/leading-experts-weigh-in-on-growing-the-us-economy-in-2024/. Accessed January, 2025.
2. The Conference Board Economic Forecast for the US Economy. https://www.conference-board.org/publications/pdf/index.cfm?brandingURL=us-forecast. Accessed January, 2025.
3. GDP By Industry. https://www.bea.gov/data/gdp/gdp-industry. Accessed January 2025.
4. Stocked Closed 2023 Near Record Highs. https://finance.yahoo.com/news/stocks-closed-2023-near-record-highs-heres-what-wall-street-thinks-is-coming-in-2024-124134109.html. Accessed January, 2025.
5. GDP International Comparisons Economic Indicators. https://commonslibrary.parliament.uk/research-briefings/sn02784/. Accessed January 2025.
6. iShares Core US Aggregate Bond ETF (AGG). https://tinyurl.com/4k9kettu. Accessed January 2025.
7. United States Inflation Rate. https://tradingeconomics.com/united-states/inflation-cpi. Accessed January 2025.
8. United States Unemployment Rate. https://tradingeconomics.com/united-states/unemployment-rate#:~:text=Rate%20Unexpectedly%20Falls-,The%20unemployment%20rate%20in%20the%20United%20States%20went%20down%20to,by%20478%2C000%20to%20161.661%20million. Accessed January 2025.
9. The Fed Cut Interest Rates by Another 25 Basis Points – Here’s What Will Get Cheaper. https://www.cnbc.com/2024/12/18/fed-cuts-interest-rates-by-25-basis-points-what-will-get-cheaper.html. Accessed January 2025.
10. Market Yield On U.S. Treasury Securities At 10-Year Constant Maturity, Quotes On An Investment Basis. https://fred.stlouisfed.org/series/DGS10. Accessed January, 2025.
11. Real Earnings Summary. https://www.bls.gov/news.release/realer.nr0.htm. Accessed January, 2025.
12. ICE BofA US High Yield Index Option-Adjusted Spread. https://fred.stlouisfed.org/series/BAMLH0A0HYM2. Accessed January, 2025.
13. ICE BofA Corporate Index Option-Adjusted Spread. https://fred.stlouisfed.org/series/BAMLC0A0CM. Accessed January, 2025.
14. Market Outlook 2025: Navigating Cross Currents. https://www.jpmorgan.com/insights/global-research/outlook/market-outlook. Accessed January, 2025.
15. What Is The National Deficit?. https://fiscaldata.treasury.gov/americas-finance-guide/national-deficit/. Accessed January, 2025.
16. It Was A Very Good Year. https://www.schwab.com/learn/story/it-was-very-good-year#:~:text=2024%20was%20another%20year%20of,through%20the%20end%20of%20the. Accessed January, 2025.
17. A Roadmap For DOGE’s 30 Percent Budget Cut. https://thedailyeconomy.org/article/a-roadmap-for-doges-30-percent-budget-cut/. Accessed January, 2025.
18. 2025 Earnings Preview. https://insight.factset.com/sp-500-cy-2025-earnings-preview-analysts-expect-earnings-growth-of-15. Accessed January, 2025.
19. Could The S&P 500 Close At 7000 By The End of Next Year. https://www.morningstar.com/news/marketwatch/20241219212/could-the-sp-500-close-at-7000-by-the-end-of-next-year-how-investors-should-read-rosy-2025-projections. Accessed January, 2025.
20. Market Concentration Update. https://melottefa.com/market-concentration-update/. Accessed January, 2025.
21. Stock Market Future Prices. https://www.axios.com/2024/10/31/stock-market-future-prices-americans-survey. Accessed January, 2025.
22. 2025 Earnings Preview. https://insight.factset.com/sp-500-cy-2025-earnings-preview-analysts-expect-earnings-growth-of-15. Accessed January, 2025.
23. Backtest Portfolio Asset Allocation. https://www.portfoliovisualizer.com/backtest-portfolio#analysisResults. Accessed January, 2025.

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