THE ECONOMY 2025: WILL IT BE A BROKEN RECORD OF PREDICTABLE CYCLES?
CONSUMER SENTIMENT: WHY SUCH WEAKNESS DESPITE STRONG JOB GROWTH?
THE STOCK MARKET: CAN TECH STOCKS CONTINUE THE MOMENTUM?
SPECIAL REPORT: THE DEPARTMENT OF GOVERNMENT EFFICIENCY
JOHN NORRIS Chief Economist
DAVID MCGRATH, CFA Managing Director Associate Managing Director
At the end of 2023, very few had high expectations for the upcoming year. There were any number of headwinds facing the economy, and the U.S. stock markets had just had a surprisingly strong year. The U.S. was going to have a contentious election season, and the geopolitical climate was a mess.
So uncertain were the prospects for 2024, most folks would have been more than happy with middling economic activity and modest investment returns. As we all well know now, both the economy and stock market more than exceeded expectations.
• Employers kept adding jobs, creating consumers in the process.
• The federal government spent trillions of dollars it didn’t have.
• Local and state governments, awash in tax receipts thanks to inflation, went on a buying spree.
• Businesses invested massive sums in new technologies.
In fact, the best way to describe 2024 is that just about everything behaved much different than anticipated.
There was one noticeable exception. What passes for civil discourse in our society remained decidedly uncivil.
Toward the end of what had already shaped up to be a good year, the Federal Reserve finally decided inflation was contained enough to start cutting the overnight rate. This seemed to add a fuel to the proverbial fire, as did November’s election results.
SAM CLEMENT
Now, whether people can tolerate Donald Trump’s personality or not, it seems business owners, consumers and investors liked the prospects for an extension of the Tax Cuts and Jobs Act of 2017, perhaps even a permanent one. Further, the presumption is that the Republican Party will be more “business-friendly” than the Democrats, what with the promise of lower corporate tax rates and less regulation.
Whether these things come to pass is still anyone’s best guess, but investors apparently remain hopeful.
Still, the question remains: what can the U.S. economy and stock market do for an encore after a surprisingly strong 2024? Will they have enough fuel to generate similar results in 2025?
The path of least resistance is to anticipate more, shall we say, subdued returns. That doesn’t mean the markets or the economy are going to fall apart. Far from it. Still, a repeat of this past year’s outsized performance isn’t statistically likely. It would be like expecting the Dodgers’ Shohei Ohtani to hit 50 home runs and steal 50 bases again this upcoming season.
Can he do it? Sure. However, considering he was the first person to ever do this in one season, and he had never previously done either until this past year, it remains far more of a possibility than a probability.
Therefore, let’s look back on this past year as one that exceeded everyone’s expectations, and be happy about it. As for moving forward, it is best to be hopeful for a decent, if unremarkable, year.
We shall see.
Thank you for your continued support.
John Norris Chief Economist & Chief Investment Officer
Our Investment Committee distributes information on a regular basis to better inform our clients about pending investment decisions, the current state of the economy and our forecasts for the economy and financial markets. Oakworth Capital currently advises on approximately $2.2 billion in client assets. The allocation breakdown is in the chart below.
The year 2024 was another strong year for performance, even though we started to see signs of strain. Amid Middle East and Eastern European turmoil, higher interest rates and domestic union strikes, the S&P still managed to deliver an impressive 23% return. Markets defied early-year predictions of a slowing economy or recession. Yet the consumer still felt like they couldn’t quite get ahead. Despite this lack of confidence, the markets continued to thrive and Washington continued to report on record economic activity.
Throughout 2024, the Investment Committee positioned our portfolio to best navigate these developments while staying nimble enough to capture upside potential. As highlighted below in our 2024 timeline, multiple marketchanging events prompted tactical shifts in our asset allocation.
While global events often dominate headlines, much of the world’s revenue and profits remain concentrated in the U.S. economy. This raises a compelling question: Why don’t American investors pay greater attention to what’s happening in the wider world? Perhaps the better question is: why would they?
By parsing through the data and leveraging our proprietary investment research, we were able to create a clear investment thesis, block out the noise and invest accordingly.
To that effect, Oakworth’s Investment Committee successfully managed risk while capitalizing on the benefits of a strong domestic economy. If you would like some insight into the primary shifts we made in our clients’ portfolios, we invite you to contact your Oakworth client advisor or investment portfolio manager, or set up a time to meet with one.
3rd
Jeffery Epstein’s inner circle named in 2015 court documents
10th
SEC approves Bitcoin ETF
30th
Crypto selloff after SEC announces stablecoin regulations
11th
The Chiefs win the Super Bowl…again
22nd
CME predicts 6 rate cuts for 2024 after FOMC meeting 10th
Odysseus lands on the moon
23rd
Nvidia’s valuation hits $2 trillion
7th
Sweden joins NATO as 32nd member
10th
Bank of Japan ends negative rate policy, impacting global bond markets
13th
Congress bans TikTok 17th
Putin wins again, with 88% of vote 2nd
Taylor Swift becomes a billionaire
3rd
Disney shareholders prevail, CEO Bob Iger wins over Nelson Pelt
29th
Universities struggle to end pro-Palestinian protests; Columbia suspends students
17th
The Dow closes above 40,000 for the first time
20th
Red Lobster files for bankruptcy
23rd
NCAA permits schools to pay athletes
30th
Trump convicted on 34 counts in hush-money trial
3rd
Sheinbaum becomes Mexico’s 1st female president
18th
At $3.34 trillion, Nvidia is valued ahead of Microsoft and Apple
27th
Biden-Trump debate raises concern for Biden’s mental health
13th
Trump survives assassination attempt
19th
CrowdStrike outage disrupts millions of Microsoft devices
21st
President Biden withdraws from presidential race
8th
Russia exits the Black Sea grain deal; wheat & crude oil prices surge
11th
Paris Olympics wrap up
13th
Starbucks replaces CEO Narasimhan with Chipotle’s Brian Niccol
21st
Ford Motor Company halts EV rollout
10th
Auto worker strikes disrupt supply chains
16th
Death toll in the Russo-Ukrainian War reaches a million
18th
Fed lowers interest rates by 0.5%. Finally
27th
Hurricane Helene devastates Southeastern U.S.
1st
Dockworkers strike halts operations at key U.S. cargo ports
10th
Hurricane Milton batters Florida
13th
SpaceX lands booster rocket – advancing reusable technology
31st
Dodgers win 8th World Series title
5th
Trump defeats Harris; GOP takes Congress
7th
The Fed cuts target rate by 0.25%
29th
U.S. stocks hit 2024 highs on chip stocks
3rd
South Korea’s Yoon Suk Yeol declares martial law; gets impeached
8th
Syrian rebels take Damascus
29th
Jimmy Carter dies at 100
As 2024 drew to a close, a mix of economic shifts, political contradictions and market realities revealed a year where perception often clashed with reality. The consequences are set to shape 2025.
It has been so long since the Federal Reserve had a “normal” easing cycle that many investors seem to have forgotten an important distinction: the Fed only cuts the overnight rate, not all interest rates. In fact, long-term rates often go up when the Fed is making rate cuts.
According to Ballotpedia.com, some 95% of incumbents, nationwide, won their races. That seems to be about the norm. So much for “draining the swamp.” It seems everyone hates Congress but loves their congresspeople.
The U.S. dollar strengthened in the global currency markets, despite the Fed cutting rates. This wouldn’t have happened if the remainder of the world’s primary economies were functioning at a high level. They aren’t.
Americans are predisposed to distrust what their politicians tell them. There is one exception: Donald Trump. Everyone apparently believes everything that comes out of his mouth, even when he doesn’t believe all of it himself.
Despite all of the advancements in technology, the U.S. elections revealed that we still struggle with basics. In this case, counting ballots in a timely manner. However, you can take your pick of any number of other examples.
If you were to only take the media’s word for it, Americans are at each other’s throats. However, it is incredibly difficult to find that same level of animosity between actual people.
Bond investors seeking safety always seem surprised when they go down in value. However, rising interest rates, especially on the long end, make this inevitable. It is just the math. It has always been this way, and always will be.
About the time everyone has forgotten about cryptocurrencies, they come roaring back to life, and everyone wants to jump in. Trust me, when my 88-year-old father starts asking about Bitcoin, it’s time to sell. We’ll call it the Jack Norris Barometer.
A trend in the international sector seems to be emerging. Foreign stocks often do their best in the 4th quarter. This is likely driven by institutional investors rebalancing their portfolios at year end and adding to their underperforming investments to meet target weighting(s).
There was a lot of frustration over the federal government’s relief efforts for Hurricanes Helene and Milton. This underscored a very basic truth. We don’t pay the government enough for it to be everything we want it to be. However, we pay too much for what it actually is.
Americans love their tech stocks. It doesn’t appear to matter what the valuations are, as that is where the growth is going to be. While this approach seems intuitive, history suggests investors can suffer a lot of short-term pain in exchange for the long-term gain.
Yet another quarter has passed, and no one has given a good reason why anyone should still care about the Dow Jones Industrials Average.
Inflation remains a challenge for the average American consumer, though not as severe as in the past two years — at least according to authorities. However, something suggests monetary policy alone isn’t going to solve the issue this time. Washington simply has to quit flooding the economy with cash.
After the surprising strength of the past two years, one has to reasonably wonder what the U.S. economy can do for an encore. It appears all bets are off.
John Norris
FIRST: REVIEWING THE PATH TO 2024
Toward the end of 2023, I participated in a podcast with a nationally recognized economist about the prospects for the upcoming year. His forecast for the first half of 2024 was decidedly pessimistic, as he expected U.S. Gross Domestic Product (GDP) to shrink around 2.0%. By comparison, I was practically Pollyannaish with my outlook, at roughly 1.5% growth during the first two quarters.
At the time, he enjoyed much greater company than I did, and for good reason.
• The yield curve had been inverted since the middle of 2022, an indicator that almost always portends slower economic growth.
• Sentiment gauges suggested the U.S. consumer was exhausted, while the NFIB Small Business Optimism Index implied corporate America was anything but optimistic.
• When we recorded the podcast, the Conference Board’s U.S. Leading Index, historically a pretty good predictor of economic activity, had been negative for 21 consecutive months.
• For their part, the ISM Manufacturing PMI was telling us that domestic manufacturing had entered a recession, and the Services PMI was well below the historical average.
• The money supply in the U.S. financial system had shrunk almost $1 trillion since hitting an all-time high in April 2022.
Source: Bloomberg
The chart above shows how much both ISM Reports on Business had fallen after reaching a peak at the end of 2021.
In essence, virtually every commonly used economic report was calling for a slowdown in U.S. activity. The question wasn’t whether things would cool down. It was by how much. So much so, that when I threw out my 1.5% forecast, the other fellow looked a little surprised.
When the Bureau of Economic Analysis (BEA) announced 1st quarter 2024 GDP to be 1.6%, I must have seemed like a genius. However, something strange happened after that.
the u.s. economy, despite the many headwinds, actually accelerated. it grew an estimated 3.0% during q2 of 2024 and 3.1% during q3.
Instead of being a recessionary year, 2024 was one of very solid growth. While no one in their right mind would ever argue about better-thanexpected economic activity, more than a few economists and analysts were left scratching their heads.
How could they have been so wrong?
First things first, thanks in no small part to massive amounts of government largesse, the domestic economy ended 2023 on very
firm footing. This is important because something as diversified and complex as the U.S. economy doesn’t just stop on a dime, and its turn radius would be measured in miles, not inches.
As such, regardless of all negative reports, the likelihood of U.S. GDP falling from 3.2% during the 4th quarter of 2023 to, say, -2.0% at the start of 2024 wasn’t likely. To that end, I thought the other economist’s negative forecast was almost as crazy as he found my slightly positive one.
One thing is certain: neither he nor I fully anticipated Washington’s massive deficit spending this past year. To say the government has been goosing the economy would be an understatement.
• At the end of November 2023, a week or so before we went into the studio, the U.S. Treasury’s total outstanding public debt was an estimated $33.879 trillion. This was up roughly $2.465 trillion over the previous 12 months.
• At the end of November 2024, it was $36.087 trillion, an increase of an additional $2.209 trillion.
It is interesting to note U.S. GDP “only” increased $1.407 trillion over the 12 months ending on Sept. 30, 2024. It makes one wonder what happened to the other $800 billion, doesn’t it? To that end, if anyone thinks the government is a better allocator of capital than the private sector, how does it justify borrowing $2.209 trillion in order to generate only $1.407 trillion in economic activity?
Source: Bloomberg Financial
However, all of that “extra” money had to go somewhere, even if it might not have been to its proverbial “highest and best use.” U.S. consumers, despite their gloom, continued to spend money freely. For their part, businesses kept buying transportation equipment, technology, inventory and, (most importantly), hiring workers.
This is incredibly important in a consumer-driven economy like ours.
• When businesses add staff, they create paychecks.
• When they create paychecks, they create consumers.
• The more consumers there are, the more stuff they buy.
• The more stuff they buy, the faster the economy grows.
ergo, how goes the u.s. labor market is how goes the u.s. consumer, and how goes the u.s. consumer is how goes the u.s. economy.
Make no bones about it, the U.S. job market this past year was not as strong as it was in either 2023 or 2022. After the massive collective hiring spree in those years, it only made sense that domestic employers would slow things down in 2024. In fact, you wouldn’t have been alone if you thought U.S. businesses would actually start reducing headcount, but they didn’t.
In fact, for the 12 months ending on Nov. 30, 2024, U.S. employers, including the government, added 2.274 million net, new payrolls. That is an average of 189.5K per month. Given the “median usual weekly earnings of full-time wage and salary workers” was $1,165/week for the 3rd quarter of 2024, that works out to be roughly $137.759 billion in new payroll per year (new payrolls X usual weekly earnings X 52). That is a significant amount of new money that has to go somewhere. That somewhere being: food, gas, utilities, clothing, housing, televisions, phones, etc.
In essence, what is good for job creation is good for the economy, and any new job is better than no job at all. Further, despite higher debt service costs and all the negative sentiment gauges, corporate America was able to continue its profits during the year, arguably a little more than anyone really suspected. Obviously, that helped with the hiring decisions.
But how much longer can the jobs machine continue to fuel economic growth? Perhaps more interestingly:
why have the consumer sentiment gauges been so weak when job growth has been as strong as it officially has?
Something doesn’t make sense.
The answer to the second question is pretty simple. According to the Federal Reserve, wealth creation in the U.S. economy since the end of 2022 has been extremely unequal, in both absolute and relative terms.
The chart below shows just how wide the wealth gap in the United States has grown in a relatively short period of time.
At the end of 2022:
• The Bottom 50% of U.S. households controlled roughly $3.474 trillion in net worth, with $9.316 trillion in assets and $5.842 trillion in liabilities.
• Conversely, the Top 10% had a combined net worth of $90.007 trillion, with $94.520 trillion in assets and only $4.513 trillion in debt.
• For its part, the Top 1% controlled $40.451 trillion in total assets, and had total liabilities of $940.822 billion.
Fast-forward to the 3rd quarter of 2024:
• The Bottom 50% had an aggregate net worth of $3.894 trillion, an increase of around $420.838 billion.
• By comparison, the Top 10% has seen its net worth grow $17.558 trillion, with the Top 1% making up $8.788 trillion of that total.
If that weren’t alarming enough, over that almost two-year time frame, the Bottom 50% has seen its liabilities increase by $188.729 billion to $6.031 trillion — this, in a rising interest rate environment. Conversely, the Top 1% has seen its debt profile actually go down by $9.864 billion to “only” $930.958 billion.
In essence, in the recent rising rate environment, the poorest among us have seen their overall level of debt increase AND their debt service soar. Obviously, this leaves them in a more precarious financial situation to meet their monthly bills even if their net worth has increased.
Put another way, the Bottom 50% has seen higher interest rates essentially gobble up much of the increase in the value of their assets. Alternatively, these rates have barely impacted the Top 1%. This is how people can be wealthier on their balance sheet and still fall behind. As a result, the rich get richer and the poor get poorer.
Fortunately, the Federal Reserve has recently embarked upon an easing cycle, cutting the overnight rate in September, November and December of 2024. This has helped the average American household. However, debt service costs are still substantially higher than they were at the end of 2021. ARE
That is an additional, roughly 4.25% on most types of variable rate debt, which hurts.
The Fed will have to cut the overnight rate at least another 100 basis points (1.00%) in order for John Everyman to begin to feel any real relief. Of course, when that happens, asset prices should climb, and the rich will get richer still. If it seems like wealth/income inequality is currently “baked” into our system, it sort of is.
That is the reason so many Americans feel as though the economy isn’t as good as the government has been saying. Their higher financing costs are offsetting most of the gains they have been making elsewhere. Finding and having a job helps to mitigate the pain, but doesn’t completely alleviate it.
As for the future of job growth in the U.S. economy? The tea leaves and crystal balls throughout the country suggest it will slow, but not collapse, to kick off 2025. Basically, you can expect more modest payroll growth than what we have experienced over the past several years. That is just the “low-hanging” fruit bet after years of outsized gains.
If you have to have a number, a reasonable guesstimate would be a monthly average of around 120-125K net, new payroll jobs over the next 12 months. That is roughly a 35% decline, and would be where I would set the over/under line if I were making a book on it. If I had to bet on that line, I would place $100 on the under and $50 on the over.
In the end, and here at the end of 2024, I didn’t do the same podcast with the same folks as I did last year. However, my forecast would be about the same for the first half of next year, around 1.50% GDP growth. After the surprising strength of the past two years, in particular, one has to truly wonder what the U.S. economy can do for an encore.
With that said, it doesn’t stop on a dime for anyone.
The goal of efficient government spending isn’t just to reduce the deficit but to ensure sustainable, effective public programs.
Chris Cooper
With the U.S. general election behind us, attention turns to proposed policy changes during a Trump 2.0 presidency. Major talking points of the Trump administration surround the efficiency of our government’s spending. From discussions on the ever-increasing national debt to fiscal responsibility, many are focused on the impact that the new administration will have on the federal deficit. Taxpayers have good reason to demand accountability after the Pentagon failed its seventh consecutive audit.
Enter the Department of Government Efficiency (D.O.G.E.) – an unofficial department with an initiative aimed at reducing federal
waste—a cause many Americans support, but few believe will succeed. It’s lack of official power and authority has been met with pause from the start.
This initiative is not new to the global political landscape.
Movements like that of Javier Milei in Argentina, who advocates for drastic cuts to government spending and the purging of public agencies, have brought attention to the debate on fiscal responsibility.
• So, what change can we expect from D.O.G.E.?
• Will the impact be felt by the “average” American?
• Will the federal deficit actually shrink?
While we can only speculate what changes will actually come from D.O.G.E., co-chair Elon Musk has stated the unofficial department could slash around $2 trillion of federal spending by cutting regulation, eliminating waste, abolishing redundant agencies and downsizing the federal workforce. We know the U.S. federal government is big, but to have those recommendations add up to $2 trillion worth of savings would be quite the feat. The key word, here: “recommendation.” An official department or office requires an act of Congress (per Article 2, Section 2, Clause 2.3.6 of the U.S. Constitution). So, any meaningful action will still require at minimum an executive order, and possibly a passage of law by Congress before any change occurs. To be blunt, Mr. Musk will need to convince lawmakers on both sides of the aisle that the recommendations are safe and sound while resulting in meaningful cost savings.
Take a trip back in time to seventh-grade civics class – Congress controls the “purse strings” of the federal budget. Most recently, Congress barely avoided another shutdown as the debt limit was raised until June 2025. The composition of these continued resolution bills varies, but one thing is sure: most federal spending is “essential,” while only some is less than essential. The U.S. federal budget can be divided into several categories, including discretionary spending, mandatory spending and interest on the national debt.
• Discretionary spending refers to funds that Congress has the authority to adjust annually, such as defense and education programs.
• Mandatory spending, on the other hand, includes programs like Social Security, Medicare and Medicaid, which are set by law and cannot be easily changed without legislative reform.
• The goal of D.O.G.E. is to identify and make recommendations to cut programs that are deemed unnecessary, consolidate overlapping services or reform entitlement programs to make them more sustainable.
As of the 2024 fiscal year, the federal budget is projected to be just north of $6 trillion. A significant portion of this budget is allocated to mandatory spending, which is expected to total approximately $3 trillion. This includes entitlement programs such as Social Security, Medicare and Medicaid, which are all growing due to an aging population. With Social Security largely driven by fixed calculations, there is little flexibility within this $3 trillion expense. Efficiency gains are limited to addressing the roughly $3 billion worth of improper payments made each year.
Another idea here could be to push back the retirement age, so as not to deplete Social Security altogether, but this was recently voted down 93-3 in the Senate. If Congress is not willing to strip a few years away from voters receiving their Social Security benefits, do we think Medicare and Medicaid will be reformed in a cost-reduction manner? Don’t count on it.
In addition, rising short-term interest rates since the Federal Reserve’s 2022 hikes have caused national debt interest payments to surge, nearing $1 trillion annually. Had the U.S. Treasury issued more long-term debt in 2020, when the 10- and 30-year U.S. Treasury yields were around 0.7% and 1.4%, respectively, borrowing costs would be far lower today. Instead, reliance on short-term debt has driven costs higher in the current rate environment. Again, simple math and no room for efficiencies here. That totals more than half of the federal budget, effectively off-limits for adjustments.
The U.S. government budget summarizes the federal government’s final revenue (receipts) from taxes and other sources, and expenditures (outlays) on public services and other expenses.
Outlays: Total amount the government spends on
and other expenses
Source: U.S. Department of the Treasury
The other side of the budget is discretionary spending, which accounts for about $2.6 trillion in the 2024 budget. This covers a wide range of government functions, including defense, education, transportation and research. This will be D.O.G.E.’s playground. Recommendations will be made to slash wasteful spending, reduce administrative/bureaucratic headcount and potentially eliminate departments entirely. Once again, Mr. Musk may make recommendations to the president, but the reality of checks and balances across the three branches of government means any significant changes to federal spending will require support from over half — and sometimes up to 60% — of Congress.
If there is a blueprint for governmental deconstruction, look no further than Argentina’s president Javier Milei. Much of Milei’s one-year stint as president has centered around drastically reducing government expenditures, privatizing state-run industries and slashing public sector jobs. Sound familiar? Milei’s campaign gained traction by tapping into public dissatisfaction with government inefficiency, corruption and an unsustainable fiscal trajectory. The results have been staggering. Argentina has recorded a budget surplus in 2024, following the aggressive tactics. His proposals, which include reducing government ministries, cutting subsidies and privatizing state-owned companies, have been controversial. However, they have also made significant strides in taming inflation and turning the federal budget into a surplus in 2024. While Milei’s approach may not be directly parallel to the U.S. government’s, it highlights a key issue that D.O.G.E. is grappling: the tension between reducing government spending and maintaining essential public services. Advocates of aggressive fiscal cuts argue that the government has grown too large and inefficient, while critics warn such cuts could weaken essential social programs and services or fail to meaningfully reduce the nation’s massive deficit.
Is the point of all this to run the federal government at a surplus? Is that even possible? Probably not, at least in the short term. However, could we see some material change resulting in positive impact in the longer term? We’ve seen the “snowball effect” throughout U.S. history.
• The introduction of welfare reform in the 1990s, for example, started with relatively modest changes to the social safety net but eventually led to a broader transformation in U.S. social policy.
• Similarly, the push for tax reform in the 1980s began with small, targeted cuts but eventually led to a major overhaul of the tax code.
These efforts might have had a modest beginning, but the ability to sustain the conversation and build momentum for deeper reforms was felt over the years and on into today.
Don’t expect a surplus in 2025, or even 2026 for that matter; but over time, new disciplines might allow for a leaner federal government and better stewardship of the American taxpayer resources.
The Department of Government Efficiency could end up playing a crucial role in addressing the challenges of government spending and budget deficits. Through its efforts to streamline operations, reduce waste and improve efficiency, D.O.G.E. will strive to ensure that taxpayer dollars are used effectively. While political movements like that of Javier Milei in Argentina may advocate for more drastic measures, the broader conversation about fiscal responsibility is critical to fostering a culture of efficiency in government. Even if the immediate impact of budget cuts may not be substantial, the ongoing dialogue about fiscal discipline can create the conditions for meaningful, long-term reforms.
Ultimately, the push for greater efficiency in government spending is not just about reducing the deficit today but about ensuring that government programs continue to serve the public in a way that is both sustainable and effective.
As we enter 2025, can the market sustain such strong returns of the past two years? While a 24% annual return from the S&P 500 seems unlikely, investors can still look forward to a solid year ahead.
David McGrath, CFA®
If you liked the equity markets in 2023, you probably enjoyed what the stock markets did in 2024. The average stock in the S&P 500 had a solid year, but the index as a whole delivered an exceptional performance.
• Markets enjoyed falling inflation numbers, followed by the first interest rate cuts from the Federal Reserve.
• The labor market remained stronger than most economists feared (much like 2023).
• This led to a resilient consumer in the face of higher prices over the past few years.
• That resilient consumer led to a very strong year for corporate earnings.
With only 4th quarter earnings season left, we should end 2024 with S&P 500 earnings per share around $243, or 10% higher than 2023 earnings.
The Magnificent 7
You can’t discuss the performance of the 2024 stock market without talking about the largest stocks in the index, also known as the Magnificent 7. The performance of these stocks (Apple, NVIDIA, Microsoft, Alphabet, Amazon, Meta and Tesla) continued to pull the return of the S&P 500 to lofty levels. The average return of these companies in 2024 was 61.7%!
When comparing the returns of the S&P 500 to the Equal Weight S&P 500 ETF, you not only see the dramatic impact the Magnificent 7 had on the returns the past two years, but also how similar the past two years have been.
*Simple
The average return of the 500 stocks that comprise the S&P 500 was just under 14% in both 2023 and 2024. A two-year stretch of around 24% is impressive by any standard, placing it firmly in the range of a historically strong performance.
NVIDIA was the stand-out performer again in 2024, with a return of 176%. NVIDIA started the year with a market cap of $1.19 trillion and ended 2024 at $3.4 trillion – a 12-month gain of $2.2 trillion. The 21 companies in the S&P 500 energy sector accounted for $1.58 trillion in market value. So, NVIDIA not only matched that but added an extra $620 billion on top. Not a bad year, to say the least.
The incredible performance of the Magnificent 7 over the past two years has made the S&P 500 more “top heavy” than at any point in the past. The top 10 stocks now account for almost 40% of the entire index. Back in the dot-com bubble of 2000, the largest 10 companies comprised just under 25% of the S&P 500 index. Today, the largest five companies alone account for almost 29%.
So, what does this mean going forward for the S&P 500?
First, the performance of the largest stocks will have a super-sized impact on the performance of the S&P 500 index, for better or for worse. The past two years it has been for better. Much better!
For reference, the largest three stocks in the S&P 500 index (Apple, NVIDIA and Microsoft) have the same impact as the bottom 350 stocks combined in the S&P 500.
The valuation of the S&P 500 is higher than it has been in some time, driven by growth stocks, which typically trade with higher P/E multiples than value stocks. This concentration in growth stocks has pulled the S&P’s forward P/E 500 ratio to 21.8x the next 12 month’s earnings.
As reference, the last two times the S&P 500 approached this valuation was early 2022 and during the dot-com bubble in 2000.
The potential for volatility within the S&P 500 is going to be higher than we have seen in some time.
Most investment analysts talk about the stock market and the S&P 500 interchangeably. I, for one, am guilty of this.
Moving forward, the S&P 500 may not be a great reference on how the average large-cap domestic stock is performing. Could we end up with an S&P 493? Doesn’t have the same ring to it.
An investor who is solely invested in the S&P 500 has never been less diversified. Large concentrations in equity portfolios can both build and destroy wealth.
And if you thought those seven stocks held a large weight in the S&P 500, it’s even more pronounced in the NASDAQ Composite, where the Magnificent 7 makes up nearly 54% of the index . Not surprisingly, the NASDAQ index had a great 2024. The mid- and small-cap sectors performed more in line with the equal weighted S&P 500, while the EAFE international index continued to struggle when compared to any of our domestic stock indexes.
Performance
Looking at the 11 economic sectors of the stock market, strong returns from the technology, consumer discretion and communication services sectors come as no surprise. However, the standout performance of the financial and utility stocks was a more unexpected highlight.
Financial Stocks: Financial stocks benefitted from the strong consumer, along with changes in interest rates. With short-term interest rates moving down and longer rates moving higher, banks will make more profit from new loans as the cost of deposits move down and the interest rates on loans move higher.
The new Trump administration has given some indication that the regulatory environment should become a bit softer for financial institutions as compared to the outgoing Biden administration. This has been a tailwind for financial stocks.
Utility Stocks: The rise of artificial intelligence (AI) and the continued adoption of electric vehicles (EVs) are driving a surge in electricity demand. Electricity consumption will only continue to grow. Even after a difficult 4th quarter, the utility sector closed 2024 with a 20% return.
On the negative side, the healthcare, real estate, energy and materials sectors all struggled in the 4th quarter, leading to flat performance for the year.
As we move into 2025, can the market sustain such strong returns as we’ve seen in the past two years? While it’s unlikely we’ll see the S&P 500 returning 24% a year, that does not mean investors can’t also have a very nice year in 2025.
As in any year, stock returns are usually driven by corporate earnings. For 2025, we are expecting the S&P 500 to produce earnings up another 10% from 2024 earnings. Earnings estimates for the year ahead are often overly optimistic, but that was not the case in 2024. If we can repeat that in 2025, we would be off to a great start. Even with no multiple expansion in 2025, this level of earnings growth should allow for a nice stock market return. And if the new Trump administration reduces tax rates on either the corporate or individual front, earnings could come in even higher, much like they did with the tax cuts of 2017.
Again, much will depend on the strength of the labor market and the resilience of the U.S. consumer. Hiring has slowed, but we have not seen any significant layoffs in the current labor market.
The market is also expecting another 50 basis points in rate cuts from the Federal Reserve. If we can see core inflation move closer to the Fed’s 2% target, the market would be very receptive to any additional help from the Federal Reserve.
The markets will also be very interested in the success of the new Department of Government Efficiency. The (growing) $36.2 trillion national debt should hamper economic growth over time, and any potential help on that front would be welcomed by equity markets.
The year ahead holds a lot of uncertainty for the markets. Nonetheless, we continue to remain cautiously optimistic about what the next year will bring.
Sam Clement
Simply put, it has been a hard year to complain about. Of course, some investors can always find a reason – but that’s nothing new. .
This year marked a notable and positive shift in the global investment landscape, despite doom and gloom from a whole host of sources. While economic uncertainty, continued inflationary pressures and fluctuating interest rates persisted, investors were greeted with a relatively stable market environment in 2024. This allowed equities to shine, as corporate earnings, economic
growth and investor sentiment all aligned to provide a favorable backdrop for stocks to largely move up and to the right. It’s a familiar story: U.S. equities continued to lead the way, driven largely by large-cap tech stocks. But there was a differentiator from 2023, too: the market’s strength broadened out beyond large-cap tech stocks, with more names and sectors contributing to the stellar year.
FIXED INCOME
On the flip side, the fixed-income market had a far less exciting
2024. Despite sharply rising bonds in previous years offering silver linings for some investors, 2024 failed to deliver the same level of excitement. With interest rates remaining relatively high and inflation slowing only gradually, fixed-income securities— particularly long-duration bonds—suffered. Investors holding bonds with any sort of duration faced flat or modestly
negative returns as the interest rate environment continued to weigh heavily on bond prices. The bond market’s lackluster performance was compounded by the uncertainty over central bank actions, creating an environment where the excitement in the equity market did not translate over to the bond market.
Ultimately, 2024 served as a reminder of the dynamic nature of financial markets, reinforcing the adage that “the majority of returns are driven by asset allocation.”
Our overweight to equities over both cash and fixed income continued to be the right call this year as the equity markets continued chugging along.
Though a welcome development for investors, the strong rally in equities throughout 2024 may set the stage for a tougher outlook this year. With stocks reaching new highs and valuations climbing to lofty levels, the market faces an increasingly challenging environment for sustaining the momentum.
This very question leaves little room for error as investors turn their attention to 2025. As discussed in previous quarterly pieces, earnings matter, especially over the long run. Earnings multiples can expand and contract over the short run but sustained longterm growth and compounding rely on earnings growth. This sets the stage for higher earnings expectations priced in for the coming year. Achieving returns similar to this year’s success will require delivering on those expectations. That doesn’t mean it’s not possible, just a higher bar.
So, what does this mean for our overall equity allocation?
Given the current backdrop, we continue to want to overweight equities, specifically domestic equities. In our prediction piece (see page 26), we continue to forecast the likelihood of the U.S. markets continuing to outperform. While things may be rocky here at times, international investing is largely a relative game. And when comparing our outlook to the rest of the world, things look pretty good. Inflation is mostly under control, and our economy continues to grow. The same cannot be said for the rest of the developed world, emerging markets or the oncefavored China.
Within our domestic equities, allocating more to small-cap, mid-cap and value stocks — all with more attractive valuations — helps to “lower the bar” for the earnings growth we need to expect. And to add to it, any additional rate cuts we see in 2025 should help to lift these areas of the market.
This is what we mean by positioning ourselves for a broadening out, which we have already started to experience this year. It is no longer just the mega-cap tech names that are contributing to the markets returns. While most of those are still doing great, we have begun to see more names and sectors doing well. These include financials, industrials and even some staples. More names contributing to the overall returns is a sign of a pretty healthy market.
While equities have lofty expectations, the playbook for solid returns is pretty clear. However, for fixed income, the roadblocks that are in place make that playbook for a strong year far less certain. One of the main challenges is the uncertain outlook for Federal Reserve policy. After aggressive rate hikes in 2022 and 2023 and sharp cuts in late 2024, the market appears set for a pause from the Fed. Though inflation has improved, core inflation remains above the Fed’s 2% target and the labor market isn’t budging much. This has made the Fed’s job a little more difficult. With their dual mandate of maximum employment and price stability not fully achieved due to lingering inflation, it has forced them to walk a tight rope of slowing things down enough to rein in inflation… but not slowing too much to significantly impact the labor market. I would not want that job.
For bondholders, this means that the interest rate environment may stay restrictive for longer, keeping bond prices lower, especially for long-duration bonds, creating an environment with downside risk and uncertainty. Not a great combination.
Adding to the Fed’s challenges is the U.S. government’s large (and growing) budget deficit, which will continue to drive up our growing debt. The government’s spending on defense, social programs, and other expenditures, coupled with the rising costs of servicing the national debt, ensure Treasury issuance will remain high, with close to $2 trillion in new debt expected next year. Increased Treasury issuance will boost bond market supply, putting downward pressure on bond prices if demand from foreign investors doesn’t keep pace.
What has this translated to for our fixed income allocation? Simply put, we want to be underweight, and we do not want to extend our duration. Accomplishing these has helped insulate the bond portion of client portfolios from the impact of rising longer-term interest rates.
The year 2025 seems to have a lot of uncertainty for the markets. Maybe that is true, or maybe that is just the natural feeling that comes with entering a new year, especially after such a good 2024. Who knows. Nonetheless, we continue to remain cautiously optimistic about what the next year will hold. Not a repeat of 2024, but all-in-all we still expect economic growth and corresponding earnings growth. That alone should be enough to generate a decent return for the following year, given the cards we are currently playing with. A broadening out has begun, and we think that’s a trend that should continue. As a result, we continue to position our portfolios to capture this opportunity with a broad portfolio, overweighting a wide range of domestic equities while underweighting fixed income and cash.
While we have a sense of confidence in our predictions, one prediction that I know will come true, is that things will change, and new highs and lows will appear next year. With that being said, we will continue to remain flexible and opportunistic, looking for opportunities to capitalize on whatever may arise.
Market uncertainty, political gridlock, energy challenges and global instability set the stage for a year of volatility and cautious expectations, according to our Investment Committee.
• After two consecutive years of outsized returns, it remains to be seen what U.S. stocks can deliver in 2025. The easymoney bet would be for increased volatility and lower returns in the upcoming year. However, you could have said that about 2024 as well.
• There is currently nothing in the crystal ball to suggest international investments will significantly outperform U.S. ones. There isn’t a legitimate threat to the dollar’s hegemony, and the U.S. economy is poised to outperform the remainder of the G-7 for the foreseeable future.
• Any hiccup in the U.S. equity market during the first half of 2025 will hit crypto markets like the flu. This is getting to be a pretty predictable cycle of wild rallies, sharp crashes and prolonged stagnation —on repeat. Expect a return to sanity in 1st quarter.
• The Bureau of Labor Statistics (BLS) and Bureau of Economic Analysis (BEA) will make negative revisions to the employment and Gross Domestic Product (GDP) data. Neither will end up being as strong as originally announced, and a lot of people will call it a conspiracy.
• At over $36 trillion and counting, the U.S. Treasury can ill-afford to have long-term interest rates get too high. The debt service will simply be too much. Expect the Federal Reserve to announce it is going to stop balance sheet reductions at some point in the New Year. It is only a question of timing. This should be enough to keep long-term rates from climbing significantly higher.
• It would require divine intervention for Justin Trudeau to remain prime minister of Canada throughout 2025. In fact, he might already be out of office by the time this magazine goes to print (as I type this on 12/23/2024). So could a lot of other world leaders. Such is the crisis of global leadership (or lack thereof).
• The Republicans will likely squander their opportunity to fully consolidate their power by fighting amongst themselves. If they are smart, the Democrats will use the time in 2025 to recraft their message and elevate electable future leaders.
• Internet, semiconductor, software and computer stocks combined make up well over 40% of the S&P 500. While they’ve fueled much of the U.S. economy’s growth, the yawning gap between growth and value stocks will have to converge at some point in the notso-distant future.
• Donald Trump has promised he will do a zillion different things in his second term as president. He won’t be able to deliver on many of them. No one could. This will cause some disappointment amongst his supporters, and a sense of relief from his detractors.
• By hook or crook (don’t ask which), the U.S. will make significant progress toward ceasefires in both Eastern Europe and the Middle East. A ceasefire, however, is one thing and peace is another. There will never be true peace in either of those regions as long as all sides remaining standing.
• In 2025, it will become even more obvious the U.S. electrical grid is unprepared for the new economy. Electric vehicles, data centers, accelerated computing and other forms of artificial intelligence consume an enormous amount of energy. Almost ironically, California, where a lot of the new technology originates, will experience the most disruptions from power outages and brownouts.
• At the end of 2024, the Fed had telegraphed two more 25-basis-point (0.25%) rate cuts for 2025. By mid-year, the Fed will have the data it needs to make additional cuts should it choose to do so.
• The retail and restaurant industries will experience a fair amount of turmoil in the upcoming year. Although the 2024 holiday shopping season was better than many anticipated, it still wasn’t enough to keep many companies from undergoing necessary restructuring. This is a clever way of saying store closures.
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This report does not constitute an offer to sell or a solicitation of an offer to buy or sell securities. The public information contained in this report was obtained from sources and vendors deemed to be reliable, but it is not represented to be complete and its accuracy is not guaranteed.
The opinions expressed within this report are those of the Investment Committee of Oakworth Capital Bank as of the date of publication. They are subject to change without notice, and do not necessarily reflect the views of Oakworth Capital Bank, its directors, shareholders and associates
