Great Year, Tough Week into Holidays
What happened last week?
The S&P 500, Dow, and Nasdaq fell by -1.99%, -2.25%, and -1.78%, respectively.
Along the way, the Dow endured stretch of losses for 10 straight days, its longest losing streak since 1974. Still, the S&P 500, Nasdaq, and Dow are up 24.3%, 30.4% and 13.7% year-to-date.
As 2024 comes to an end, the Federal Reserve raised its estimate for US growth this past year from 2.0% to 2.5%. It raised its expectation for core inflation by 0.3% next year to 2.5%.
Despite this, the Fed concluded its final policy meeting of 2024 with another 25 basis point rate cut, taking its policy rate down 100 basis points since September. As a base case, it doesn’t intend to stop rate cuts altogether.
3 Things to Know
Higher Volatility and More Moderate Returns
The 54% gain for the S&P 500 in the past two years came from a depressed 2022 (-19% that year). Still, the pace of equity market gains has been unsustainably rapid.
We expect overall corporate profits to grow at high single-digit pace in both 2025 and 2026 and the Fed to carry through with a further modest policy easing to protect the labor market.
As we examined in our Wealth Outlook 2025, the weakness in corporate profits and the economy in 2023 leaves the economic recovery at a less advanced “age” than many believe. With this, we continue to expect a wider swath of US and global equities to make progress in 2025.
As Fed Chair Powell noted, the “lags” in normalizing the economy are still at work. He used the late timing of realized insurance costs, in some cases ratified by state governments, as a prime example of why consumer prices have not come down quickly. These same dynamics do not bear on the future inflation outlook.
At a much larger share of US inflation measures than insurance, shelter price inflation is coming down with the usual long lag in measurement. Early year price spikes may again spook markets in 2025. And as Powell noted, the Fed will have to take tariffs and other new administration policies into account. It is unlikely, however, that the Fed will see itself as failing to return inflation to a level consistent with its long-term target.
Fed Policy Expectations Are Highly Variable
Market expectations for Fed policy rates are highly erratic. At the same time, we hear many investors argue that the Fed should set rates at a stable level and not “tinker.” This is simply inconsistent with the Fed’s historic behavior.
The Fed has constantly adjusted monetary policy to evolving US labor market conditions which are much more variable than in other economies. A substantial decline in open job postings is consistent with a rising unemployment rate.
As Powell has said, the Fed has no desire to see this continue. For this reason, we continue to expect three quarter-point rate cuts in 2025, taking the Fed funds rate to 3.75% at its higher bound.
Pullback Has Improved Return Outlook for 2025
The history of the past two decades, with the Fed’s US policy target rate averaging a mere 1.70%, is unlikely to be repeated in the decade ahead, even if some future recession brings the rate to such a level temporarily.
However, peak rates are not lasting even if investors are back to worrying about “higher for longer” at this moment.
The drop in US equities from December’s highs, and especially, the drop in global equities from pre-US election highs, has improved the return outlook for 2025 even if returns were never set to match the 2023–2024 pace.
While we still expect long-term bond yields to edge up next year, it is only because of our expectation of persistent growth. With the market reaction of the past month, the probability that monetary policy shocks or disappoints in the coming year has been greatly reduced.
See our weekly CIO Strategy Bulletin for more details