Despite various headlines, geopolitical tensions, and other risks, the stock market posted a second year of strong returns, with the S&P 500 up 25%. As we look forward to 2025, it is important to understand what happened in 2024 that led us to this point.

Economics

Coming into 2024 there was a heightened sense of concern, fueled largely by geopolitical tensions and inflation concerns, reflected by nearly 50% of economists predicting a recession to occur during 2024. The pessimistic predictions of the year were anything but accurate, as the US consumer remained strong, business activity picked up, and inflation showed signs of deceleration. The table below shows how several key economic measures changed during the year, with most indicators showing continued strength and cautious optimism for the year ahead.

Interest Rates

At the end of 2023, the Federal Reserve had finished its hiking campaign at a target of 5.50% but vowed to remain “data dependent” before cutting rates. Markets disagreed, though, with consensus estimates expecting seven rate cuts in 2024 with an end-of-year target of 3.75%. Similarly, the year's actual result differed from the projection, as a strong economy mixed with sticky inflation led Jerome Powell and the FED to only cut to 4.50% before signaling a pause moving forward.

Coming into the year, the 10-year Treasury rates were below 4%, and the yield curve was inverted, a rare occasion where longer-dated Treasury rates were lower than short-term Treasuries. As the year progressed, the actions of the FED and broader economic data caused rates to move materially across the curve, with front-end rates falling substantially, while 3- to 30-year rates rose well above 4%, ultimately leading to a more normal upward-sloping yield by year-end.

Fixed Income

Coming into the year, US Fixed Income markets offered relatively attractive yields across most sectors, from Treasuries to Mortgages and Corporates. The interest rate volatility throughout the year led to volatile bond performance, especially in the second half of the year, as rates rose rapidly following a FED pause. Despite the interest rate volatility, spreads tightened throughout the year, approaching historically tight levels. All major US Fixed Income indices posted positive returns, with shorter-duration and spread sectors (Corporates, Asset-backed, etc.) outperforming.

Equity Markets

Following a strong year in 2023, where the S&P 500 was up 26.29%, the Street came into 2024 expecting muted returns and heightened volatility, especially in the face of potential stagflation (slowing GDP mixed with elevated inflation). Predictions were once again incorrect, as major US indices experienced positive gains, with most broad indices up more than 10%.

Regarding relative performance, conversations around valuation, index concentrations, and AI hype were key topics of conversation coming into the year, with many market participants hoping for a value rotation and small-cap rejuvenation. Instead, the US stock market experienced much of the same in 2024, with an extremely strong return, driven by mega-cap technology and names related to the AI megatrend. The “Mag 7” contributed approximately 13.4% of the S&P 500’s total return of 25%, accounting for over half of the return.

How Markets are Shaping up for 2025

In terms of the economy, the positives include the downward trend of inflation, near-full employment, strong consumer confidence, and improving economic activity; In contrast, downsides include housing affordability, rising debt levels, delinquency rates, and global trade relations. Fixed Income markets start the year with attractive yields and strong company balance sheets but expensive valuations, with spreads near all-time tights.

Equity markets are in a similar situation, with positive trends of AI and efficiency serving as tailwinds helping to drive an expected 15% growth in earnings; however, valuations are expensive, and the biggest weights in the S&P 500 are priced for near perfection, so they need to continue their strong execution.

2024 is a great example of how beginning-of-the-year projections are not perfect representations of the year to come. It is important to understand how the current macro backdrop may impact markets moving forward. As we move forward into 2025, the aggregate data shows reasons to be cautiously optimistic about the US economy and broad asset class potential returns.

Disclosure: This article is only general information and should not be taken as investment advice. This article should not be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy.

Author: Jason T. Pettner, CFA, CFP®, is a Senior Analyst at CS McKee.

Editor: Greg Filbeck, CFA, FRM, CAIA, CIPM, PRM, Samuel P. Black III, Professor of Finance & Risk Management, Penn State Erie, mgf11@psu.edu

Data Sources: Bloomberg