Week of January 6, 2025

Key Points for the Week

• The U.S stock market had strong returns for the second year in a row. • There are policy risks to monitor during 2025.

Current Trends & News is a weekly financial recap curated by SPC Financial®’s team of wealth management and tax-integrated advisors.* We monitor and explore the intricacies of the financial world and share insights into market developments.

Economic Update

Stocks in the United States delivered a double-double—posting double-digit gains for a second year in a row. That kind of performance is a relative rarity and has only occurred nine times over the last 96 years, according to Tony DeSpirito of BlackRock.

Throughout 2024, share price gains were supported by several factors, including:

• Enthusiasm for Artificial Intelligence (AI). Magnificent Seven stocks had another big year.

“The group…averaged a gain of 65 [percent] this year, compared with an average of 111 [percent] last year, according to Dow Jones Market Data. The Mag 7 has made up 57 [percent] of the S&P 500’s…market [capitalization] gain this year versus 65 [percent] last year.”

Emily Dattilo, Barron’s

• Strong corporate revenue and earnings growth. Many publicly traded companies have been making more money and growing profits. For the full year 2024, analysts expect companies in the S&P 500 to report year over year earnings growth of 9.4 percent and revenue growth of 5.1 percent. In 2025, expectations are even higher. Earnings growth was forecast to be 14.8 percent and revenue growth 5.8 percent for the year, reported John Butters of FactSet.

• A solid U.S. economy.

“Over the last few years, the U.S. economy has consistently defied expectations for a slowdown, and 2024 was no different. Despite uncertainty around a presidential election, elevated interest rates and a cooling labor market, economic growth remained solid this year.”

Augusta Saraiva, Bloomberg

• Steady consumer spending. A key driver for the economy was robust consumer spending.

“Even as hiring slowed, wage growth continued to outpace inflation and household wealth reached new records, supporting an ongoing expansion in household spending.”

Augusta Saraiva, Bloomberg

• Anticipation of Federal Reserve rate cuts. For much of the year, investors eagerly anticipated Federal Reserve (Fed) rates. In general, when the Fed lowers the federal funds rate, borrowing becomes less expensive which can boost corporate earnings and share prices, explained Mary Hall of Investopedia.

These factors helped U.S. stocks repeatedly set new record highs during the final quarter of the year. However, the stock rally stalled in December after the Fed expressed concerns about inflation and modified its forecast for 2025 rate cuts amid slower progress on inflation and an uncertain policy outlook, reported Sarah Hansen and Bella Albrecht of Morningstar.

In the bond market, many sectors delivered positive returns over the full year 2024. However, quite a few gave back some gains in the last months of the year.

“Bond markets saw a major selloff in the fourth quarter, sparked by the outcome of the U.S. presidential election and the potential for stronger economic growth, inflationary policies, and more deficit spending in the years ahead.”

Sarah Hansen and Bella Albrech, Morningstar

The yield on the benchmark 10-year U.S. Treasury note started the year at 3.95 percent and finished the year at 4.58 percent.

Last week, which was shorter than usual due to the New Year’s holiday, major U.S. stock indices finished lower. The yield curve continued to steepen as yields on shorter maturities of U.S. Treasuries fell, while yields on longer maturities rose.

This Week in the Markets

Last Tuesday, December 31, was the final trading day of the year. The S&P 500 stumbled a bit into the end of the year — the last all-time high close for the year was on December 6th, but it was a good year for the widely followed index.

Below are some charts that were introduced throughout the year that provide a review of what occurred in 2024.

Chart 1: The President’s Party Is Not a Market Predictor

2024 was a presidential election year and we covered the election from a market perspective. Throughout the election, we reinforced that investing based on one’s political beliefs tends to be a fundamental mistake when it comes to markets. Policy matters, but markets do not necessarily respond to policy at the time and in the manner expected and the macroeconomic environment matters more. (For example, during President Trump’s first term, energy stocks did poorly, despite an easier regulatory environment.) The bottom line is that if you were not in the market because you did not like the politics of President Obama, or President Trump, or President Biden, you missed out on some gains. Our first chart is the S&P 500 under various presidents. The most meaningful pattern is not what happens when it is red or blue, but it is overall historical rise due to the ability of companies to grow earnings.

Charts #2 and #3: Broad-based Gains Supported by Fundamentals

A lot has been written on how the S&P 500 is dominated by a small number of very large technology-oriented companies, sometimes called the Magnificent Seven. The index has indeed grown increasingly concentrated, but returns were much broader based than just seven names. As the chart below shows, those names did contribute a little over half the gains of the S&P 500 in 2024, although that is partially a function of their weighting in the index. (Note that performance here is strictly for the sake of understanding the market and should not be considered a recommendation.) In fact, the Equal Weight S&P 500 Index, where the Magnificent 7 only receive 1.4% of the weight, still had a total return of 13.0% in 2024. That does lag the cap-weighted index by more than 10%-points, but it also brings home that the environment for stocks in general was really pretty good in 2024.

Another theme we hear is that stock gains have been driven by valuations (multiples growth) where investors are simply willing to pay more for a dollar of profits. But as seen in the chart below, earnings growth has been a major contributor to stock gains this year. Of the 25% total return for the S&P 500 in 2024, 13%-points can be attributed to earnings growth and 2%-points can be attributed dividends, leaving 10%-points to multiple expansion. Yes, the index’s P/E has been rising and that does have the potential to pull from gains in the future, but it is important to keep in mind that a lot of stock market performance continues to be driven by “fundamentals” (earnings growth and dividends). In fact, looking back over the last five years, the S&P 500 has had a total return of 97%. Of that, 76%-points can be attributed to fundamentals, leaving 21%-points for multiples expansion.

Chart 4: The Dollar

The US dollar index gained over 7% in 2024, a significant jump for the world’s reserve currency. The dollar index is now at its highest level in over two years and its climb captures most of the dynamics we saw in 2024, including:

• Strong US economic growth, on the back of above-trend productivity growth • Outperformance of the US economy relative to other developed and emerging markets, as the rest of the world struggled • A summer scare for the labor market, which increased expectations for the Fed to go for a big cut in September (which they did) and dollar weakness • Rising interest rates in the US after September which led to dollar strength, amid strong economic data and the Fed taking recession risk off the table by committing to protect the labor market • A relatively bigger monetary policy easing cycle in other developed economies, as central banks look to boost growth, even as the Fed may be in pause mode during the first half of 2025 • Post-election dollar strength is also a reminder that tariffs will be a focus in 2025 • Yet another year of US equity outperformance relative to international stocks, with the dollar acting as a major headwind. Japan was a prime example: the MSCI Japan index gained over 21% in local currency terms (easily besting the Dow’s 13% return, and not too far below the S&P 500’s 25% gain). However, the net USD-based return was only 8.3% thanks to the yen depreciating over 12%.

Chart 5: The Yield Curve

The Treasury yield curve (the relationship between short-term and long-term interest rates) also tells a lot of the story of 2024. As you can see below, over the course of the year, we went from a largely inverted yield curve at the end of 2023 (short-term rates higher than long-term rates) to a normally sloped curve at the end of 2024 (higher long-term rates). This happened because short-term rates have fallen well below where they were at the end of 2023 and long-term rates have risen. The pivot point is the two-year yield, which hardly moved.

That change tells a lot of the economic story for the year. Short-term yields fell on Fed rate cuts, although fewer than expected at the start of the year as the economy topped expectations. Long-term yields rose from a combination of improved growth expectations and increased uncertainty around inflation.

On a forward-looking basis, the change in the curve tells us that 10-year Treasuries are starting with a 1.78%-point head start versus 3-month Treasuries to open 2025 compared to the start of 2024 (a three-month yield that is 1.09%-points lower and a 10-year yield that is 0.69%-points higher than the start of 2024). 10-year yields have been climbing with some momentum, but that is a nice head start for intermediate Treasuries versus the start of last year. Also, keep in mind that when the 10-year Treasury yield peaked in October 2023, the fed funds rate was a full percentage point higher and trailing year core CPI inflation was still over 4%, conditions that are much more conducive to higher rates than what we have today.

Policy Risks to Monitor in 2025

The 119th Congress was sworn in last Friday, with Republicans taking over majority leadership in the Senate and holding onto the House with the narrowest majority in the history of the Republican party. Policy mistakes could come from a lot of different places: the incoming Trump administration, Congress, the Federal Reserve, or even the Supreme Court. We review the ones that we think could have the greatest market impact below.

Lower taxes, deregulation, higher fiscal deficits, and lower interest rates are all policies that tend to have a positive impact on corporate profits, which in turn support stock gains. There is also the added factor of a rebound in the subdued economic confidence we have seen in recent years. Lingering pandemic fatigue and inflation spiking to its highest level in over 40 years in mid-2022 significantly dampened economic sentiment. In response to that, voters ousted incumbents at a high rate in 2023 and 2024. Left or right, if you were in power during the period of high inflation, voters said it was time for a change. In the US, confidence has been low despite economic growth over the last eight quarters surpassing anything experienced during either the Obama or Trump administrations (outside the immediate reversal of the pandemic recession).

While the potential policy environment will be favorable, it is also not without risks. In fact, much of the risk is just from the opportunities failing to materialize. Keeping that in mind, below are some of the key policy risks markets may face in the year ahead.

Risk 1: The Federal Reserve Keeps Policy Too Tight

The first risk is not related to the Trump administration or Congress at all, but rather the possibility that the Federal Reserve keeps monetary policy too tight. The Fed is currently in a rate cutting regime, but expectations of the pace of rate cuts have slowed quite a bit. Shifting expectations is mostly due to improved growth expectations, which is a positive, but also a significant rise in inflation expectations. The Fed’s perception of both inflation uncertainty and the direction of inflation risk changed substantially from September, as shown below, and that has led to greater caution around rate cuts.

Remember, a fed funds rate target of just 2.25 – 2.50% nearly broke the economy in 2018 – 2019, something President Trump correctly pointed out at the time, and low rates, even after some tightening, were still a major tailwind. Well, right now the target fed funds rate target is at 4.25 – 4.50%, two full percentage point higher. The economy has been incredibly resilient despite high rates, but cyclical sectors, including housing, small businesses, and manufacturing, have been under pressure and the labor market, while still strong, has exhibited some underlying risk, although it remains quite stable for now.

Productivity growth, which is supported by a tight labor market and has been an important contributor to recent growth, may also be damaged by policy that is too tight if it leads to a rise in layoffs.

Risk 2: Tariffs Push Inflation Higher

There has been a lot of speculation about tariff policy. A strong dollar, partly in anticipation of tariffs but also due to growth rate differentials between the US and other developed economies, can also act as an inflation buffer. At this point, inflation expectations remain well anchored, but it is a delicate balancing act.

The S&P 500 fell over 6% in 2018 as the Fed tightened policy, and the trade war was raging. The path of interest rates and uncertainty around tariffs are risks, and they are not the only ones.

Risk 3: Internal Division within the Republican Party Delays or Limits Policy Implementation

This is a policy risk that has a positive side. We noted during the election that markets tend to like mixed government. The spirit of compromise tends to get us better policy and helps avoid the ideological excesses of both parties, but we will not have mixed government in 2025. When the new Congress was sworn in Friday, Republicans held narrow majorities in both the House and Senate. As of inauguration day on January 20, we will also have a Republican president in the Oval Office.

The majorities will be narrow. Republicans will hold a 53-47 majority in the Senate, as well as the tie-breaking vote by the vice president after January 20. Republicans would have held a 220-215 majority in the House, but Florida Republican Matt Gaetz resigned and two Republican House members will take positions in the Trump administration. That will make the Republican majority 219-215 until the members assuming new roles resign and then 217-215 until special elections can be held. (Unlike the Senate, replacements in the House cannot be appointed, only elected.) There is no tie breaker in the House, so at that point Republicans will not be able to lose even a single vote in the House when a vote is along party lines.

We did not get divided government, but there are ways in which narrow majorities keep at least some of the spirit of divided government. Republicans will need their own moderates and their most hardline conservatives to vote yes to pass policy. If Freedom Caucus members hold up a bill, some Democrats could potentially be pulled on board to support it if they believe it is in their interest, but it would require some compromise. If Republican moderates hold up a bill due to it pushing too far to the right, it is very unlikely Democrats will come to the bill’s rescue.

This occurred with the current House’s recent efforts to fund the government. Republicans needed some Democrats to support the bill. Trump intervened as president-elect to object to the initial bipartisan continuing resolution (CR), but 38 Republicans rejected Trump’s alternative. A somewhat stripped down version of the original CR was finally passed with more Democratic votes than Republican. Trump’s interventions did lead to some changes, but the overall effect was small. From the perspective of the current House, a narrow majority led to compromise, although things will be somewhat different once Republicans control the Senate and Trump has been inaugurated.

Narrow majorities keep more checks and balances in place, but they also increase the possibility of legislative chaos and will make it more difficult to pass any bill that does not have broad consensus among Republicans. Significant delays that disappoint policy expectations could lead markets to become impatient with congressional infighting. Keep in mind that Congress will have to deal with raising the debt ceiling and government funding in Q1 2025, let alone the important fiscal cliff associated with expiring individual tax cuts at the end of 2025.

A Cold New Year’s Tradition

People around the world like to welcome the new year by putting on a bathing or wet suit and immersing themselves in cold water. The name of the event—Polar Bear Plunge, Christmas Swim, or New Year’s Dive—varies by location. Of course, water and air temperature vary greatly, too, depending on where the plunge takes place. Here are a few examples from the United States on January 1, 2025.

Coney Island, New York/Atlantic Ocean Air temperature: 50.0 degrees Fahrenheit Water temperature: 40.5 degrees Fahrenheit

Myrtle Beach, South Carolina/Atlantic Ocean Air temperature: 60.0 degrees Fahrenheit Water temperature: 58.4 degrees Fahrenheit

Milwaukee, Wisconsin/Lake Michigan Air temperature: 30.0 degrees Fahrenheit Water temperature: 39.7 degrees Fahrenheit

San Diego, California/Pacific Ocean Air temperature: 60.0 degrees Fahrenheit Water temperature: 57.1 degrees Fahrenheit

According to Cleveland Clinic Health Essentials, submerging yourself in cold water for short periods may have health benefits. For people who are in good health, cold-water baths may ease sore muscles, reduce inflammation, improve circulation, and promote better sleep. (It remains unclear whether New Year’s Day plunges confer any of these benefits.)

A Reminder About Scams

Scams usually start with a phone call, email, text, or another form of communication. The person typically claims to be from an agency or organization you know – or one that sounds like it might benefit you, such as the National Sweepstakes Bureau or a lottery.

The person may know your name and address. They may give you their official title or an identification number. No matter how official they seem, you can be confident it is a scam if the person contacting you:

• Indicates there is a problem with your benefits. • Asks you to pay to receive a prize. • Suggests that paying will increase the chance of winning. • Requests financial information, such as a bank account or credit card number. • Pressures you to act immediately. • Tells you to pay using a specific method, such as a gift card or cryptocurrency.

If this happens, remember that the Social Security Administration, the Internal Revenue Service, Medicare, and your bank do not call, email, or text to ask for money or personal information. They do not demand that you pay immediately, and they do not accept payment by gift card, prepaid debit card, cryptocurrency, or another untraceable form of money transfer.

When you suspect a scam:

• Hang up or close the message. Do not respond in any way. • Remain calm. • Think back over the call. Write down any personal information you may have inadvertently shared. • Report the scam. Contact the Federal Trade Commission at ReportFraud.ftc.gov. You may also want to report the incident to your state’s attorney general or your local consumer protection agency. • Share your knowledge. Talk with family, friends, and neighbors about your experience so they know what to look out for.

When you receive a digital message, no matter how official it seems, do not click on any links. Do not give or confirm any personal information, including your name, birth date, phone number, address, email address, place of birth, driver’s license, passport, or Social Security numbers, bank or other account numbers, and PIN numbers.

Being skeptical can keep you safe. Remove yourself from the situation. Do not share information. If you feel anxious and need to confirm that it was a scam, contact the organization using a method provided on their official website.

How To Avoid Tax Scams

Below is a link to a video provided by the IRS to help avoid tax scams:

https://www.youtube.com/@irsvideos

If you have any questions, please contact us.

Did you Know? This Week in History

January 6, 1975: “Wheel of Fortune” Premieres

Wheel of Fortune, one of the longest-running syndicated game shows in American television, premiered on NBC on January 6, 1975. Created by television legend Merv Griffin and hosted since the early 1980s by Pat Sajak and Vanna White, Wheel is one of the most popular television shows in the world.

Griffin, who had already created another iconic game show, Jeopardy!, conceived of Wheel as a combination between Hangman and roulette. Contestants guess letters as they attempt to solve a Hangman-like puzzle, spinning the wheel to determine how much money they will earn for a correct guess, with the goal being to solve the puzzle and accumulate as much money as possible. Since the show's inception, the price of a vowel has stood at $250 and has not been adjusted for inflation. The phrases "I'd like to buy a vowel" and "I'd like to solve the puzzle" have entered the American cultural lexicon.

Sajak and White, who joined in 1981 and '82, respectively, have become some of the most famous hosts in game show history. White, who operates the board and reveals letters as they are guessed, often contributes her own puzzles to the show. In more than 6,500 episodes, she has apparently never worn the same gown twice. The show's producers claim that more than 1 million people have auditioned to be contestants and the show has paid out a total of more than $200 million. Painfully awkward or incorrect guesses by contestants have also been comedic fodder for generations of Americans.

Weekly Focus

“Write it on your heart that every day is the best day in the year.’”

Ralph Waldo Emerson, Philosopher

”One can choose to go back toward safety or forward toward growth. Change must be chosen again and again.”

Abraham Maslow, Psychologist