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Quarterly Markets Overview & Outlook

John Merrill, Tom Bruce, Curtis Holden, CFA®, January 3, 2025

OVERVIEW. Asset class performances diverged in 2024 as they reacted to the cross currents of a strong U.S. economy, weakness abroad, geopolitical tensions, a flip-flop from the Fed on interest rates, and anticipation of the new President’s policies after the election.

U.S. stocks were the big winners, led by the familiar giant tech companies. Gold also surged amid central bank buying and heightened geopolitical tensions.

Foreign stocks were hit hard in the fourth quarter which greatly reduced their full year returns.

Bonds and other interest rate sensitive assets (REITs, infrastructure) performed very well through the end of the third quarter but gave a lot back in the fourth quarter when it became apparent the Fed would not reduce the FFR as much as previously believed.

Table 1 shows the results for the major asset classes for the fourth quarter and the full year. All returns are total returns which include reinvested dividends, interest, and capital gains.

CASH. Cash held in money market accounts delivered a good return in 2024, supported by the Fed’s elevated interest rates. Schwab's primary money market account yielded 4.3% at year end.

Money market rates are expected to remain in the mid 3% to low 4% range throughout 2025. They will likely be at the high end of this range if, as expected, the economy maintains its current strength. Should the economy soften with rising unemployment and lower inflation the rate may move toward 3% or even lower.

BONDS. Bonds experienced a very volatile year as the inflation narrative shifted. Over the first three quarters of 2024, the Fed confidently forecasted lowering its FFR because inflation was steadily coming down. Ironically, just as the Fed actually began to reduce the FFR, inflation stalled and moved slightly higher. In reaction, the yield on the 10-year Treasury bond (the market's bellweather) went up almost a full percent which caused prices on existing Treasury bonds to fall. See Chart 1.

Over the full year, the yield on the 10-year bond rose about 0.75% despite the lower level of both inflation and the FFR. The bond market is worried that both could go higher in 2025. If those worries dissipate, the yield may stabilize in the mid-4% area or come down as it did in mid-2024.

DOMESTIC STOCKS. 2024 was another exceptional year for U.S. stocks. However, performance was heavily skewed toward the largest technology companies, known as the Magnificent 7 – Alphabet, Amazon, Apple, Meta, Microsoft, NVIDIA, and Tesla – which collectively rose 64.0% last year. In contrast, smaller companies represented by the Russell 2000 gained just 11.4%. See Chart 2.

The Magnificent 7’s outsized returns can be attributed to their remarkable earnings growth. For example, Nvidia reported an impressive 111% earnings growth this year. They make the computer chips necessary for AI and their customers literally begged to purchase as many as possible amidst limited supply.

Despite the strong economy, small caps and value stocks faced significant headwinds due to elevated interest rates. Smaller companies, which rely more heavily on credit to fund operations, faced high borrowing costs. Value stocks, often favored for their dividend income, faced competition from higher yields in fixed-income markets.

Despite these challenges, 2025 may offer better opportunities for other areas of the market. Optimism among small business leaders surged post-election. See Chart 3. Proposed tax cuts could provide a significant boost to small-cap and mid-cap U.S. companies by enabling them to retain more earnings and reinvest in their businesses. Additionally, deregulation is expected to accelerate mergers and acquisitions, unlocking capital and enhancing growth prospects for smaller firms.

Analysts are also optimistic about the prospects for energy stocks, particularly in liquefied natural gas (LNG). President-elect Donald Trump has pledged to "approve the export terminals on my very first day back," signaling an acceleration of LNG investment and export growth.

The financial sector could benefit from the potential rollback of Basel III regulations, fostering a more favorable environment for bank capital structure and profitability.

Other sectors such as healthcare, logistics and U.S. manufacturing should benefit from the roll out of AI applications.

While technology stocks dominated in 2024, returns are expected to broaden in 2025 and sustain the bull market in U.S. stocks.

INTERNATIONAL STOCKS. International stocks underperformed U.S. equities for yet another year. A strong U.S. dollar played a significant role in this underperformance, as both stock values and dividends distributed in Euros, Yen, or Pounds lost value when converted into Dollars.

However, the challenges for international stocks goes beyond currency effects. Economically, financially, and politically, the U.S. continues to look stronger than most other developed markets. Much of the U.S. equity outperformance can be attributed to stellar earnings growth from the American tech giants and extensive corporate buybacks – factors largely absent in international markets.

While U.S. cash flow per share (after tax earnings plus depreciation) have shot up by 140% since 2008, total cash flow outside the U.S. has been stagnant, creating a stark divergence in corporate performance. See Chart 4. Lower rates of investment and slower productivity growth compared to the U.S. have further weighed on Europe’s profit margins and competitiveness.

In China, government measures to bolster the stock market have so far yielded limited results. Chinese equities experienced a brief rally in September, after the government hinted at new stimulus. However, the absence of a detailed and credible plan to stimulate domestic consumption has left many investors skeptical and the market gave back most of the September bounce.

Elsewhere, emerging markets only posted modest gains this year. A strong dollar increased debt servicing costs, while weak demand from China added further pressure. Foreign investment could rise next year as most central banks lower interest rates and investors seek further diversification.

Looking ahead to 2025, tariffs loom large in the minds of international investors and no one is quite sure what to expect.

REAL ASSETS. REITs, being highly sensitive to interest rates, have experienced a similar roller coaster ride as bonds this year. Early in the year there was hope that declining financing costs would boost REIT performance, but the fading prospect of significantly lower interest rates has tempered investor optimism. REITs finished the year delivering only modest gains. They are likely to continue to face headwinds so long as real (inflation adjusted) interest rates remain high.

Global infrastructure investments performed similarly to REITs, posting slightly higher mid-single digit returns. Although infrastructure is also influenced by interest rates, it is somewhat less tied to economic growth, as many projects are backed by public sector support.

GOLD. Gold posted another strong performance in 2024, albeit with a slight retreat towards the end of the year. Gold bullion began 2024 at $2062/oz. and ended at $2630/oz.

A primary factor driving gold's price is the persistent accumulation by Russia, China, and their allies. These nations are diversifying their reserves away from dollar-dominated assets to mitigate the risk of Western sanctions. Continued purchases from central banks, particularly China, would provide critical support for gold's further gains in 2025.

Geopolitical tensions, including instability in the Middle East and the ongoing Ukraine conflict, also boosted gold’s appeal as a safe-haven asset. These geopolitical issues are overwhelming gold’s historic tendency to retreat in the face of high real interest rates and a strong Dollar.

Disclosures