Market Commentary – January 2025

As we begin the new year, it’s clear that 2024 was an unexpectedly strong year for markets, defying concerns about inflation, Fed policy, and political uncertainty. The S&P 500 posted a remarkable 25% return, the Nasdaq gained 29.6%, and the Dow Jones rose 15%. International markets lagged considerably, with emerging markets up 8.1% and developed markets gaining 4.3%. 

This performance was achieved despite periods of heightened uncertainty, reinforcing the importance of staying invested during challenging times. As we look to 2025, we expect opportunities and challenges as the markets continue to navigate elevated valuations, evolving Federal Reserve policy, and geopolitical risks.  

Lessons from 2024: The Power of Staying Invested 

While many investors were cautious due to fears of a recession (“hard landing,”) inflation, and the presidential election, the stock market achieved 57 new all-time highs during 2024. Since the current bull market began in October 2022, the S&P 500 has gained 57.8%, making the past two years the strongest market performance since the late 1990s.   

Interestingly, there were only two periods of meaningful market volatility in 2024, in April and August, when indices declined by 5% or more. However, both pullbacks were followed by swift recoveries, underscoring the futility of trying to time the market. While it’s natural to wonder if a pullback is imminent when markets are near all-time highs, history shows that staying invested in a diversified portfolio is the most reliable path to achieving long-term financial goals. 

Strong Fundamentals Supporting Markets 

The strength of corporate America provided a solid foundation for the market’s performance in 2024. According to Factset, year-over-year earnings growth for S&P 500 companies in 2024 is expected to reach 11.9% when fourth quarter earnings are released.  This growth was supported by a robust economy, which expanded at an annualized rate of 2.8% in the third quarter. Inflation moderated significantly with the Consumer Price Index (CPI) increasing by just 2.6% year-over-year, moving closer to the Federal Reserve’s 2% target.  Historically, 2.6% is in line with normal economic time periods not associated with elevated inflation. The chart below shows the Personal Consumption Expenditures measure of inflation. This measure is the favored data source for the Fed and shows the progress made toward the Fed’s ultimate 2% target.  

Although interest rates remained elevated for much of the year, the Federal Reserve began cutting rates in September, lowering them by one percentage point by year-end. While these cuts were widely anticipated by the bond market, persistent inflation concerns prevented bond prices from rising significantly, as is more typical when rates fall. For the year, the overall bond market posted modest gains of just 1.3% as measured by the Bloomberg US Aggregate Bond Index. 

Diversification: The Key to Portfolio Stability 

One of the most important lessons from 2024 was the value of diversification. While technology and artificial intelligence stocks continued to dominate headlines and drive market performance, all but one of the S&P 500’s eleven sectors delivered positive returns.  

This underscores the difficulty of predicting which sectors or styles will outperform in any given year. Over long periods, a well-diversified portfolio helps to smooth returns and reduce risk by capturing gains across different parts of the market. 

Navigating Elevated Valuations and Market Risks 

As the bull market enters its third year, valuations are becoming a critical consideration. The price-to-earnings (P/E) ratio of the S&P 500 reached 21.4 in 2024, well above the historical average of 15.7 indicating that either corporate earnings need to play “catch-up” in the coming quarters or that the market may have gotten ahead of itself, a common occurrence that has played out repeatedly in the last several years. It’s very possible the resolution will be a period of higher volatility, something the market has avoided for many months.  

Geopolitical risks and fiscal policy concerns also remain top of mind. The new administration’s focus on extending tax cuts and pursuing protectionist trade policies could create both opportunities and challenges for investors. While lower taxes may support corporate profitability, rising tariffs and the growing national debt could introduce inflationary pressures and put downward pressure on bond prices. 

In this environment, our focus remains on finding balance—evaluating opportunities across sectors and asset classes while maintaining a disciplined approach to risk management. 

Federal Reserve Policy: A Balancing Act 

The Federal Reserve’s actions will continue to play a key role in shaping market performance in 2025. After reducing rates by one percentage point in 2024, the Fed is expected to make additional cuts this year, although the timing and magnitude will depend on economic data. Lower rates can support economic growth and corporate earnings, but may also fuel over-exuberance in stocks that can lead to overheating. 

Bond markets are particularly sensitive to Fed policy. If short-term rates trend lower and longer-term rates remain steady, bond prices could benefit while offering attractive yields. This presents opportunities for income generation and portfolio stability, especially for investors seeking alternatives to equities. 

We are closely monitoring these developments to ensure portfolios remain positioned for potential shifts in the rate environment. 

Outlook for 2025: Opportunities and Challenges 

Looking ahead, we anticipate a constructive environment for U.S. equities, supported by strong earnings growth and easing monetary policy. However, increased volatility is likely, driiven by elevated valuations, geopolitical risks, and potential changes in fiscal policy. 

A 10% market correction would not be surprising, given the strong gains of recent years. However, such pullbacks often create opportunities for long-term investors to increase exposure to high-quality assets at more attractive valuations. 

A positive trend we expect to continue is the broadening of market participation. While technology stocks have dominated the past two years, 2024 saw meaningful contributions from smaller companies and traditionally defensive sectors. This diversification is encouraging and underscores the importance of maintaining a balanced portfolio. 

The median year-end forecast for the S&P 500 in 2025 among 23 investment strategists is 6,600, suggesting a potential 10% return from the market’s close in 2024. While this aligns with the S&P 500’s long-term average annual return, it’s worth noting that the index rarely achieves exactly this figure in any given calendar year. Historically, market forecasts have proven to be unreliable, particularly over a 12-month horizon. For this reason, we approach these projections with caution. Below, we’ve included both 2024 and 2025 predictions alongside the actual 2024 results and current market levels. These serve as a reminder to view such forecasts critically and maintain a long-term perspective. 

The Bottom Line 

We anticipate positive returns for stocks in 2025, though a normal market correction along the way is likely. For now, we maintain a preference for U.S. stocks over international markets due to stronger revenue and earnings growth. In fixed income, our bond strategies are designed to offer diversification and return potential that we believe can outperform the broader bond index. 

While challenges will undoubtedly arise in 2025, we remain disciplined in managing portfolios that align with both your short and long-term goals. Thank you, your partnership and the trust you place in us. 

Chris Proctor, CIMA® 
Chief Investment Officer