Monthly Market Commentary – January 2025

Market Update
Stocks and bonds faced headwinds in December but finished the year with positive returns across the board.

The S&P 500 Index notched several all-time highs in early December before retreating modestly into year-end. The Federal Reserve (Fed) cut short-term interest rates by -0.25% during their policy meeting, but a cautious tone about the future direction of interest rate cuts created some uncertainty to finish the month. Against this backdrop:

• Large caps outperformed small caps as volatility returned: Large cap stocks (S&P 500 Index) returned -2.4% but outperformed small cap stocks (Russell 2000 Index) which declined -8.3%. Small caps underperformed in part due to higher borrowing rates, as they generally rely on debt financing to fund growth.
• Bonds posted negative returns as long-term rates increased: Bonds (Bloomberg US Aggregate Bond Index) returned -1.6% as the 10-year U.S. Treasury yield increased from 4.18% to 4.58% (+0.40%).
• Emerging markets outperformed non-U.S. developed market: Emerging market stocks (MSCI EM Index) declined -0.1% and topped non-U.S. developed market stocks (MSCI EAFE Index) which returned -2.3%. Non-U.S. developed market stocks were lower due to uncertainly around economic growth and the future path of interest rates.

U.S. Equities
The prospect of fewer interest rate cuts from the Fed and rising Treasury yields weighed on stocks.

The S&P 500 Index declined -3% on the day of the Fed’s December policy meeting after the U.S. central bank reset expectations for only two rate cuts in 2025. Longer-term interest rates moved higher on the news which also weighed on stocks for the remainder of the month.

• Large cap growth stocks outperformed in a return to a familiar pattern: The “Magnificent seven” stocks (Alphabet, Amazon, Apple, Meta, Microsoft, NVIDIA, and Tesla) which represent the largest companies in the S&P 500 Index returned +5.5% in December. Expectations for above average earnings growth and the potential for a favorable regulatory environment in 2025 boosted returns.

• Dividend paying value stocks lagged due to rising yields: Sectors with the highest dividend yields (Energy, Real Estate and Utilities) were amongst the worst returners during the month¹. A cautious outlook on Fed interest rate cuts and rising Treasury yields weighed on returns.

Fixed Income
Bond returns were mostly negative as Treasury yields increased during the month.

The Treasury yield curve steepened in December as the Fed lowered short-term rates by -0.25% and longer-term yields rose on the potential threat of rising inflation.

• Short-term bonds outperformed long-term bonds: Short-term bonds, which are more closely correlated to the Fed’s interest rate policy than long-term bonds, performed well on the heels of the December rate cut.

• High Yield (HY) bonds outperformed their investment grade (IG) peers: HY bonds (rated BB and below) fell -0.4% compared to a -1.9% decline for IG (rated BBB and above). HY bonds generally have a shorter maturity (compared to IG bonds) and were therefore less impacted by rising interest rates.

2024 Capital Market Review
Asset class returns were mostly positive in 2024 led by U.S. large cap growth stocks and alternatives.

Economic growth was solid as GDP averaged 2.5% over the first three quarters of the year. Strong job growth, a resilient consumer, lower inflation and an active Fed all provided support to capital markets. Within this framework risk assets performed well.

• U.S. large cap stocks led traditional asset class returns: Large cap growth stocks led equity returns for the second consecutive year (+43% in 2023) and were led higher by the magnificent seven and investor enthusiasm about artificial intelligence (AI). NVIDIA rose 171% in 2024 and was a standout in the large growth space due to their expertise in AI chips.
• Bond returns were muted as rates climbed: The current yield (4.9%) on the US Aggregate Bond Index is now the highest in over a decade. However, rising interest rates in 2024, which have an inverse effect on bond prices, weighed on the overall bond market. High Yield (+8.2%) and short-term bonds (+5.3%) posted stronger performance in 2024 due to their lower interest rate sensitivity.
• Cash alternatives continued to rise on the threat of higher inflation: Gold and bitcoin performed well as investors fretted about the impact of inflation on traditional currencies. Gold is often viewed as a safe haven with the potential to buffer losses during times of market stress. Bitcoin has become popular due to its high recent returns but those have come with the side-effect of extremely high volatility².

2025 Asset Manager Outlook
Asset manager outlooks are mixed for 2025 but mostly favor U.S. over international equities.

Leading managers (BlackRock, T. Rowe Price, and JPMorgan) recently released 2025 market outlooks which are highlighted below.

• BlackRock is constructive on risk assets and favors U.S. stocks: BlackRock believes the buildout and adoption of AI will create opportunities across sectors and industries. A robust economy, broad earnings growth, and a high-quality tilt underpin their conviction in U.S. stocks. They see valuations for large cap tech stocks backed by strong earnings, and less lofty valuations for many other sectors³.
• T. Rowe Price believes higher inflation could dampen bond returns: T. Rowe Price thinks the U.S. economy should continue to outperform peers due to fiscal and monetary support. However, higher goods prices and volatility in shelter costs could keep inflation above the Fed’s 2% target. This may lead to fewer rate cuts in 2025 and result in higher long-term Treasury yields (a headwind for bonds). Additionally, they are expecting credit spreads to widen modestly from historically narrow levels in 2024⁴.
• JPMorgan stressed the importance of diversification: Following two strong years of outperformance from U.S. stocks, valuations have become elevated, and the economy could slow to a more gradual pace of growth. Although they believe this is unlikely to trigger a recession, it does leave the economy more vulnerable to shocks from uncertain fiscal and monetary policy⁵.

Economic Calendar
U.S. job growth and consumer spending both topped expectations.

Job growth and consumer spending were crucial to the U.S. economy avoiding a recession in 2024, as both metrics were stronger than many economists expected. Employers added about two million new jobs during the year and retail sales topped forecasts for six consecutive months (June - November).

• U.S. job growth rebounded in November and exceeded expectations: +227k new jobs were created in November, versus a forecast for +214k. This was a significant increase from October (+36k) but is likely a “catch up” in hiring due to the numerous employee strikes and hurricanes that slowed job growth in October.
• Retail sales have topped forecasts for six straight months: November retail sales rose +0.7%, versus a forecast for +0.6% and marked the second highest monthly reading since January 2023. A strong labor market with low historical layoffs and strong wage growth has supported consumer spending.
• The Fed reduced expectations for 2025 rate cuts due to stubborn inflation: November inflation (CPI) was in line with forecasts (+2.7% annualized) but nevertheless has risen in two straight months. The Fed noted during their December meeting that economic growth was stronger than forecasted, while inflation was slightly higher. Given this assessment, the Fed now projects only two rate cuts in 2025, down from four expected rate cuts at their September meeting⁶.

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