The fourth quarter ended on a high note for U.S. equities capping a year of robust market performance. Fueled by favorable economic conditions, strong corporate earnings, and enthusiasm for transformative technologies like artificial intelligence (AI), the Morningstar US Market Index achieved multiple all-time highs. Despite a late December dip following the Federal Reserve’s cautious stance on 2025 rate cuts, the S&P 500 rose 2.41% for the quarter. Growth stocks outperformed value stocks with technology and communication services leading the way. Mega-cap companies like Microsoft, Apple, Nvidia, et al., which make up the Magnificent Seven (Mag 7), were key drivers of these gains, illuminating investor preference for innovation and scalability.

Large-cap stocks continued outperforming small caps, benefiting from their ability to navigate uncertain economic conditions. Small caps, by contrast, faced headwinds from higher interest rates and concerns about credit access and growth potential. Meanwhile, a mixed picture presented itself in the bond market. High-yield and leveraged loan markets showed resilience, supported by tight credit spreads and low delinquency rates. However, longer-duration bonds faced challenges as investors remained cautious about the trajectory of interest rates and economic growth. The Federal Reserve’s dovish tone in Q4 provided some stability but failed to match the strength of equity markets.

Globally, Q4 market performance varied. While the U.S. economy displayed resilience through above-trend GDP growth, robust job creation, and easing inflation, European economies struggled with high energy costs and fiscal uncertainty. Japan saw steady growth driven by corporate reforms and accommodative policies while emerging markets faced rising debt burdens and weaker demand. The fourth quarter underscored the optimism surrounding AI-driven growth while highlighting concerns about market concentration and valuations that could present challenges in 2025.

 

ECONOMIC CONDITIONS:

U.S. – Growth Ticks Higher

GDP: The economy grew at an annualized rate of 3.1% in the third quarter of 2024, revised upward from the prior estimate of 2.8% and ahead of economists’ expectations. That followed 3.0 % annualized growth in Q2 and 1.6% in Q1.[19]

Labor: Employers added 227,000 jobs in November, a rebound from 36,000 jobs added in October (revised up from the initial estimate of 12,000 jobs). The November gain was in line with economists’ expectations and confirmed what investors were hoping—that October was an anomaly due to the outsized impact of two hurricanes and a workers’ strike at a large aircraft manufacturer.20 Unemployment increased slightly in November to 4%, while wage growth increased 4.0% over the prior 12 months.

Housing: Housing starts fell 1.8%, the lowest level in four months. November’s drop was driven by a steep decline in multifamily starts which offset a gain in single-family starts.[23] Lower mortgage rates and increased inventory pulled homebuyers off the sidelines in Q4: sales of existing homes rose 3.4% in October and 4.8% in November. The median existing- home sales price was $406,100, a 4.7% increase from a year prior.[24] New home sales rose 5.9% in November. The median new home sales price in November was $402,600, down 6.3% from a year prior—the lowest level since February 2022. There were 490,000 unsold new homes on the market in November, representing 8.9 months of inventory.[25]

International: Election Concerns

Eurozone: Eurozone shares fell in Q4 amid recession fears, political instability in France and Germany, and concerns over trade wars following Donald Trump’s US election victory. Materials, real estate, and consumer staples were the weakest-performing sectors, while industrials posted gains. December’s flash PMI survey indicated the eurozone private sector remained in contraction, with the composite output index improving slightly to 49.5 from 48.[3] in November, driven by a rebound in services. The European Central Bank (ECB) cut interest rates by 25 basis points in October and December. ECB President Christine Lagarde hinted at further cuts in 2025, citing the eurozone’s ongoing struggle with weak growth. Political turmoil marked the quarter. In Germany, the coalition government collapsed in November after Chancellor Olaf Scholz dismissed his finance minister, triggering February 2025 elections. In France, Prime Minister Michel Barnier lost a no-confidence vote over his budget, with no parliamentary elections possible before July.

U.K.: UK equities declined during the quarter as domestically focused sectors faced pressure from rising long-term bond yields and concerns about the UK macroeconomic outlook. Bond yields rose in line with global trends amid upward revisions to inflation expectations but were further driven by worries over the fiscal policies outlined in the Autumn Budget. The Budget’s cost increases, including higher employer National Insurance contributions and the National Living Wage set to take effect in April, appeared to weigh on the jobs market. November hiring data showed unusually weak demand for staff ahead of the busy Christmas period. Preliminary data from the Office for National Statistics (ONS) indicated the UK economy contracted in October, marking a second consecutive monthly decline. Additionally, Q3 growth was revised down to zero from an initial 0.1%. Internationally diversified, economically sensitive sectors exposed to weakening global industrial activity also underperformed, adding to the broader market downturn.

Japan: The Japanese equity market saw gains in Q4, with the TOPIX Total Return rising 5.4% in yen terms. Developments in the US – particularly in currency markets – influenced performance as yen weakness late in 2024 improved earnings prospects for large-cap exporters, helping the market end the year positively. Uncertainty surrounds a potential “Trump 2.0” presidency, but the robust US economy has provided support. Japanese companies’ semi-annual earnings were mixed, while notable developments included the consolidation of two automakers and another firm targeting a 20% return on equity. Share buybacks surged, with announcements receiving favorable market reactions. Corporate governance reforms continued, though 2024 offered fewer catalysts for overseas investors. The Tokyo Stock Exchange disclosed exemplary and poor practices to encourage action from management. The Bank of Japan (BOJ) kept rates steady in December, with Governor Ueda adopting a less hawkish stance. Business sentiment improved modestly, and upcoming Shunto wage negotiations in March 2025 are expected to boost consumption. Banks led Q4 sector performance amid positive financial sector prospects.

 

EQUITIES: U.S. Leads Again

U.S. EQUITIES: Stocks posted solid gains in Q4 as investors navigated the presidential election, overseas unrest, and Fed rate cuts. The Standard & Poor’s 500 Index rose 2.07 %, while the Nasdaq Composite surged 6.17%. By contrast, the Dow Jones Industrial Average edged up only 0.51%. Only four of the 11 S&P 500 sectors ended the quarter in the green, but those four sectors were powerful enough to lift the Standard & Poor’s 500 stock index.

Consumer Discretionary (+11.97%) was the best-performing sector. The other three positive sectors were Communication Services (+7.09%), Financials (+6.64%) and Technology (+2.99%). Materials (−12.70%) and Healthcare (−10.68%) were among the worst performers, while Real Estate (−8.95%), Utilities (−6.30%), and Consumer Staples (−5.29%) also finished in the red. Industrials (−2.72%) and Energy (−2.44%) fell the least.[11]

DEVELOPED INTERNATIONAL EQUITIES: The MSCI EAFE Index fell 8.38% in Q4, starkly contrasting U.S. averages that benefited from post-election and holiday rallies.15 European markets were mixed during the quarter. France fell 3.34%, Spain 2.38%, and the United Kingdom 1.25%. Meanwhile, Germany picked up 3.02% and Italy 1.23%.[16] Pacific Rim markets were mixed thanks to Japan, which picked up 5.21% during the quarter.

EMERGING MARKETS: Emerging market (EM) equities declined in Q4, with the MSCI EM index falling in US dollar terms due to investor concerns over Donald Trump’s proposed tariffs, particularly on China. Brazil was the weakest EM performer as fiscal concerns weighed on its currency. South Korea suffered losses amid political turmoil, with two presidents impeached in December. South Africa, India, and China also declined, with China impacted by uncertainty over stimulus measures and trade tariffs. Saudi Arabia outperformed despite negative returns, while only four EMs—Czech Republic, Kuwait, Taiwan, and the UAE—posted positive results, with Taiwan boosted by AI-related optimism.

 

FIXED INCOME: Fewer Cuts

U.S. FIXED INCOME: US Treasuries sold off in October amid concerns over potential inflationary policies arising from a possible Republican victory in the presidential election. Inflation figures saw an unexpected uptick, leading to a rise in bond yields as the market priced in fewer rate cuts for 2025. By the end of December, the Federal Reserve (Fed) had cut rates for the third consecutive time, bringing the target range to 4.25%–4.5%, but Fed Chair Jerome Powell indicated fewer cuts might follow in 2025 due to persistent inflation concerns. The 10-year Treasury yield experienced a notable rise, finishing the year at 4.57%, indicating market uncertainty regarding the Fed’s future actions amidst rising expectations for inflation if President-elect Trump were to implement all his economic policies.

 

QUARTERLY FOCUS: A Time for Reflection

2024 was a remarkable period for U.S. equity markets. The year was characterized by robust growth, innovation, and strong economic performance. The S&P 500 delivered a total return of 25.02%, marking the second consecutive year of double-digit gains. This performance was driven by several key factors, including solid GDP growth, easing inflation, and Federal Reserve rate cuts.

AI continued to dominate headlines and market performance in 2024. The “Mag 7” mega-cap tech companies not only led the market in returns but also accounted for a disproportionate share of earnings and revenue growth. As we can see in the chart below, both earnings growth and profit margins for the Mag 7 have witnessed high double-digit growth while the remainder of the S&P 500 hovers in the single-digit range.

These firms benefited from the rapid adoption of AI technologies across industries, driving demand for cloud computing, semiconductors, and AI-driven applications. Their strong profit margins and operational scale set them apart from the broader market, further solidifying their leadership.

Growth stocks significantly outperformed value stocks in 2024, continuing the trend of investors favoring innovation and high-growth potential. Large-cap stocks also outshone small caps, reflecting investor preference for stability and scalability in an uncertain global environment. Small caps, while offering pockets of opportunity, struggled with higher interest rates earlier in the year and weaker access to capital markets.

The Federal Reserve played a critical role in shaping market dynamics in 2024. After years of battling inflation with aggressive rate hikes, the Fed shifted to a more accommodative stance, implementing several rate cuts. This policy shift supported equity valuations and reduced borrowing costs, fostering a favorable environment for corporate investment and consumer spending.

The bond market, however, lagged behind equities. Fixed-income investors experienced modest gains, as volatility stemming from Fed policy changes created challenges. High-yield bonds and leveraged loans performed better than investment-grade bonds, benefiting from tight credit spreads and low default rates. However, the overall bond market struggled to compete with the outsized returns of equities.

Globally, 2024 presented a mixed economic landscape. The U.S. economy maintained its strength, with GDP growth exceeding expectations and labor markets remaining resilient. Inflationary pressures eased, particularly in housing and energy, supporting consumer spending. Europe, on the other hand, faced significant challenges, including high energy costs, fiscal uncertainty, and declining manufacturing output. Japan achieved moderate growth, supported by corporate reforms and shareholder-friendly policies, while emerging markets grappled with rising debt levels and slower recoveries.

For mutual fund investors, 2024 was a year of stark contrasts. Funds with significant exposure to mega-cap growth stocks thrived, delivering strong returns, while those emphasizing value-oriented or bond-heavy strategies underperformed. This divergence highlighted the importance of strategic allocation and diversification.

In summary, 2024 was a year defined by strong economic fundamentals, technological innovation, and favorable monetary policies. However, challenges such as market concentration, elevated valuations, and global debt levels underscored the need for cautious optimism moving into 2025.

 

DPWM OUTLOOK: The Year to Come

The outlook for 2025 presents a mix of opportunities and challenges shaped by the momentum of the past two years and emerging risks. U.S. equities – buoyed by consecutive years of strong gains – are expected to face valuation pressures, narrowing market leadership, and increasing investor scrutiny. With the Federal Reserve maintaining a dovish stance, albeit with shallower rate cuts anticipated, monetary policy will continue to influence market dynamics.

The U.S. economy is expected to grow at a steady pace, supported by resilient consumer spending and strong corporate investment. However, elevated equity valuations and market concentration remain key concerns. The “Mag 7” mega-cap tech companies are likely to face greater scrutiny regarding their capital expenditures and the sustainability of AI-driven growth. Investors will be closely watching whether these companies can deliver positive returns on investments in AI infrastructure and applications, as well as address challenges such as high energy requirements and operational costs.

Globally, economic growth is projected to reach 3.1% with regions like Europe and Japan expected to benefit from monetary easing and structural reforms. Europe faces both opportunities and risks, as moderating inflation supports policy easing but fiscal uncertainty and energy challenges persist. Japan’s outlook is bolstered by corporate governance reforms and steady economic growth, while emerging markets continue to face high debt levels and slower recovery times.

The U.S. dollar, which strengthened significantly in 2024, is expected to remain elevated, supported by the relative strength of the U.S. economy and its attractiveness to foreign investors. However, its overvaluation could introduce headwinds, particularly for emerging markets reliant on dollar-denominated debt.

Sector opportunities in 2025 are likely to center on innovation and productivity-driven growth. Technology, healthcare, and infrastructure are poised for continued expansion, driven by AI adoption, advancements in medical technology, and digital infrastructure investments. However, investors must remain vigilant about market concentration and the potential for increased volatility, particularly in a high-valuation environment.

For investors, 2025 will require disciplined portfolio management and a focus on quality companies with sustainable earnings and growth potential. Diversification across regions, sectors, and asset classes will be critical to navigating potential headwinds and capturing opportunities. The interplay between fiscal policies, geopolitical developments, and evolving market conditions will play a significant role in shaping outcomes.

While risks such as high valuations, debt burdens, and geopolitical uncertainties remain, 2025 offers the potential for innovation-driven growth and regional recovery. By emphasizing thoughtful investment strategies and long-term growth opportunities, DPWM is positioning portfolios to weather these challenges and capitalize on an evolving market landscape.

 

CITATIONS:

1. WSJ.com, December 31, 2024
2. Insight.FactSet.com, November 1, 2024
3. WSJ.com, October 4, 2024
4. WSJ.com, November 6, 2024
5. WSJ.com, November 7, 2024
6. Reuters.com, November 14, 2024
7. CNBC.com, December 17, 2024
8. WSJ.com, December 18, 2024
9. APNews.com, December 21, 2024
10. CNBC.com, December 31, 2024
11. SectorSPDRS.com, December 31, 2024
12. TaxFoundation.org, June 26, 2024
13. APNews.com, December 12, 2024
14. WSJ.com, December 9, 2024
15. MSCI.com, December 31, 2024
16. MSCI.com, December 31, 2024
17. MSCI.com, December 31, 2024
18. MSCI.com, December 31, 2024
19. APNews.com, December 19, 2024
20. WSJ.com, December 6, 2024
21. CNBC.com, December 17, 2024
22. Reuters.com, December 17, 2024
23. Reuters.com, December 18, 2024
24. Realtor.com, December 19, 2024
25. Realtor.com, December 23, 2024
26. The Wall Street Journal, December 11, 2024
27. Reuters.com, December 23, 2024
28. The Wall Street Journal, November 7, 2024
29. The Wall Street Journal, December 18, 2024