Summary
The Fed Pumps the Brakes: Our Monthly Survey of the Economy, Interest Rates, and Stocks In 2024, November was by far the best month of the year, with the S&P 500 rising 5.7% on post-election enthusiasm toward an incoming administration viewed as business-friendly. December was another story, with the broad market index falling 2.5%. Down Decembers are not all that uncommon; the S&P 500 fell 5.9% in December 2022 and 9.2% in December 2018. What was different about the December 2024 selloff is that it occurred within a strong and rising market: the S&P 500 made over 50 new all-time highs in 2024. The recent selloff also featured an easily identifiable villain: the Fed. The U.S. central bank signaled that, after its December rate cut, it might move to the sidelines at least until mid-year and that, if the data warranted, it might not move off the sidelines at all during 2025. A key feature of the market in the second half of 2024 was intensification of the sector rotation away from traditional growth areas (Information Technology, Communication Services) to a broad swath of sectors with cyclical, rate-sensitive, and defensive characteristics. December featured a counter-rotation within that rotation, as newly favored sectors were hit hardest during the holiday month selling. The December blip notwithstanding, we believe rotation away from traditional growth leadership will reassert itself in 2025. Markets with good breadth would tend to be more durable and better positioned to withstand adverse news than thin and narrowly led markets. Conversely, if growth does not lead in 2025, it is hard to envision the S&P 500 advancing another 20% this year. The Economy, Interest Rates, and Earnings The U.S. economy GDP sustained mid-year 2024 strength into the third quarter and most likely into year-end. Third-quarter 2024 GDP reflected ongoing growth in consumer expenditures, solid growth in business spending, and a high level of spending by the federal government. The final (third) report of third-quarter GDP showed growth of 3.1%, up from a 2.8% indicated in the preliminary and advance reports. The increase from 3.0% growth in 2Q24 GDP reflected higher consumer spending, exports, nonresidential fixed investment, and federal government spending. These gains were partly offset by an increase in imports, which are a subtraction in the calculation of GDP. Personal consumption expenditures for 3Q24 increased 3.7%, up from 2.8% for 2Q24 and 2.5% for all of 2023. Spending on goods increased 5.6% in 3Q24, nearly double the 2Q24 rate. Durable goods spending rose a sharp 7.6% in 3Q24, extending second-quarter strength that reversed a decline in the first quarter. Durable goods spending was up 3.9% for all of 2023. Nondurable goods spending rose 4.6% for 3Q24. The decline in annual inflation growth has mainly been concentrated in goods, while services inflation remains somewhat elevated. Consumers now appear more willing to buy goods at stable or in some cases lower prices. Consumer spending on services grew 2.8% in 3Q24, little changed from 2.7% in 2Q24. Consumer spending on services grew 2.9% in 2023. Some of the growth in consumer services spending has been driven by rent equivalent and insurance and other costs that consumers cannot control, and many cannot avoid. After a weak first quarter for PCE, the bounce-back in the second and third quarters suggests that consumers are adapting to stubborn ‘last-mile’ inflation and structurally higher prices. We expect PCE within the GDP accounts to continue to send conflicting signals, with goods spending more volatile than services. We also believe a solid holiday season drove on-trend consumer spending in 4Q24. Nonresidential fixed investment, the proxy for corporate capital spending, rose at a 4.0% annual rate in 3Q24; this category grew at a 6.0% rate in 2023. PCE and nonresidential fixed investment represent about four-fifths of gross domestic product in any quarter. In 3Q24, consumer spending added 2.48 percentage point to GDP, while nonresidential fixed investment added 0.55 percentage point. Residential fixed investment remained negative in 3Q24, pulling back by 4.3% after declining 2.8% in 2Q24. With the timing of any further Fed rate cuts uncertain, and with long Treasury yields back at spring 2024 highs in the 4.6% range, the housing sector is a long way from healthy. The export-import balance favored imports in 3Q24, as it did in the first half, but exports were the strongest since 3Q22. Exports grew 9.6% in 3Q24. Imports were up 10.2%. Given the higher dollar value of imports, the net exports-imports balance subtracted 43 bps from overall 3Q24 GDP growth. We expect this category to remain volatile quarter over quarter. Another volatile category, the change in private inventories, subtracted 22 basis points from 3Q24 GDP after adding 105 basis points to 2Q24 GDP. Supply-chain distortions have mainly receded. Higher tariffs under the incoming Trump administration could be another potentially disruptive factor. Overall government spending was up 5.1% and added 86 basis points to 3Q24 GDP growth. Federal spending was up 8.9%, led by a nearly 14% increase in defense spending, while state and local government spending grew 2.9%. The price index for gross domestic purchases increased 1.9% in 3Q24, compared with revised increases of 2.4% in 2Q24 and 3.1% in 1Q24. And the PCE price index advanced 1.5%, down from 2.5% in 2Q24. Solid GDP growth with lower price increases gives the Fed room to cut rates going forward. Outside the generally strong GDP accounts, the economic picture is mixed. U.S. economic indicators generally suggest a mix of deceleration and optimism, with growth continuing albeit at a subdued level. On the other hand, the swing to an administration perceived as more business-friendly is now lifting small business and purchasing manager sentiment. The consumer economy continues to send mixed signals, with jobs and wages still growing – but at a slower pace. The U.S. economy generated just 43,000 new jobs in October (revised), due to the Boeing strike and the major hurricanes; return of those workers resulted in above-consensus growth 212,000 (revised) in November nonfarm payrolls. December nonfarm payrolls rose an above-consensus 256,000. While growth in new jobs continues to slow, multiple indicators of the employment economy – including the unemployment rate, wage growth, and the average work week – remained healthy in fall 2024. The unemployment rate was 4.1% in December 2024, vs. 4.2% in November and 4.1% in October. Average hourly earnings continue to grow at about 4.0% year over year. Annual wage growth continues to run above inflation, but the premium has narrowed. Industrial production decreased 0.1% in November after dipping 0.3% in October. The strike at Boeing reduced Industrial production by 0.2% in October and 0.3% in September, according to the U.S. Federal Reserve. The two major hurricanes that hit the Southeast reduced October Industrial Production by 0.1%. Capacity Utilization was 76.8% in November, the lowest since 2021 and about three points below the long-run average. The NFIB’s small business optimism index soared to 101.7 in November, up eight points from 93.7 in October, on optimism regarding a change to a more business-friendly administration. November broke a string of 34 consecutive months below the 50-year average of 98. In the months preceding the Fed’s first rate cut of the cycle in September, optimism returned to the long-depressed housing industry. After first coming down to multi-month lows following the September rate cut, market interest rates spiked higher in October into early November. The effect of lower rates on housing will be positive. Given the huge number of homes with no mortgage and those with mortgages below 4%, however, Argus is not looking for a housing surge like that seen in the pandemic period. The consumer seems slightly more optimistic, having become somewhat reconciled to higher prices. Retail sales rose 0.7% in November on top of 0.4% growth in October. Personal incomes rose 0.3% in November, down from 0.7% in October; and personal consumption spending rose 0.4%, up from 0.3% in October. The University of Michigan Consumer Sentiment Index reached 74.0 in December 2024, up from a 71.8 in November 2024 (which had been a six-month high). The November reading reflected post-election optimism on the economy and prospects for interest-rate relief. The Atlanta Fed’s GDPNow model, which has a good track record, as of early January 2025 was forecasting 3.1% GDP growth for 4Q24. Chief Economist Chris Graja, CFA, raised the Argus third-quarter and fourth-quarter 2024 GDP forecasts to 2.8%, from prior sub-2% readings. Argus now looks for GDP growth of 2.6% for all of 2024 and 2.1% GDP growth in 2025. We continue to believe the U.S. economy can avoid recession in 2025. The central bank started its rate-hiking campaign in March 2022. Sixteen months and more than five percentage points later, the Fed halted in July 2023; and it held rates steady for eight straight meetings. At its mid-September 2024 FOMC meeting, the Fed cut interest rates by 50 basis points. Prior that that, the Fed last cut rates more than four years ago in 2020, amid the extraordinary circumstances of the COVID-19 pandemic. At its November 2024 meeting, the FOMC again cut the fed funds and discount rates, this time by 25 bps each. And the Fed made one final 25-bps cut at its December FOMC meeting. That brought the tendency in the fed funds rate to 4.25%-4.50%, down 100 basis points from peak. But the most recent cut by the FOMC was accompanied by a statement suggesting that the pace of any future rate cuts would likely be pushed back in 2025 and that a data-dependent Fed might decide not to cut rates at all this year. Where the Fed goes from here may require further progress on inflation, which remains half a point to a point and a half above the Fed’s 2% target range. CPI and PPI inflation data both reached three-year lows in September but made little further progress in October and November. The Fed’s preferred inflation gauge, the core PCE price index, rose just 0.1% in November, vs. 0.3% in October. But this metric was up 2.8% year over year in November, unchanged from October. The annual change has hardly moved from 2.7% in July. Bond yields hit multi-month lows following the Fed’s September rate cuts then moved higher soon after on solid economic data and economic optimism following the election. Yields first moderated off those spiky highs, then shot higher on the Trump election win. Both middle-maturity and long-maturity yields are now back at the highs from spring 2024. The 10-year Treasury yield was 4.57% as of the end of December, compared with 4.18% as of the end of November and 3.75% as of the end of September; the cycle peak for the 10-year yield was the 4.9% level in October 2023. The two-year Treasury yield was 4.25% as of the end of December, vs. 4.13% as of the end of November and 3.55% as of the end of September; the peak level was 5.2% as of October 2023. Notwithstanding current noise in the market, Argus expects short-term yields to move lower from current levels. Long yields over time are expected to widen their relative premium to short yields. We have likely seen the end to twos-10s inversion in this cycle, but two- and 10-year yields could remain in proximity in the near term. Argus Fixed Income Strategist Kevin Heal continues to anticipate two or three additional quarter-point cuts in 2025, bringing the central tendency as low as 3.50%-3.75% by December 2025. But Argus along with the Street now expects any cuts to be back-weighted to the second half of 2025. We also see the possibility that the Fed holds rates unchanged in 2025, as it continues to monitor the economy, employment, and inflation. Heading into 3Q24 earnings season, our forecasts for S&P 500 earnings from continuing operations were $247 for 2024 and $265 for 2025. Based on another successful EPS season, we have increased our forecasts for 2025 and 2026. Our increased optimism toward 2025 earnings reflects expected better performance for three sectors that were negative in 3Q24: Energy, Materials, and Industrial. Materials and Industrial could swing to positive comparisons as soon as 4Q24 (Materials) and 1Q25 (Industrial). Energy could take a little longer, generating positive comparisons by 2Q25. For the long term, we believe return to growth momentum for the commodity-sensitive Energy and Materials sectors will depend on the success of the Chinese government’s stimulus program and other factors including potential new tariffs. The strongest EPS growth in 3Q24 came from Communication Services, and specifically the media giants Meta Platforms and Alphabet. Growth forecasts for the sector in 2025 and 2026 anticipate potential moderation from high-teens percentage growth in 2024 to low-double-digit or even high-single-digit percentage growth going forward. Other sectors are forecast to hold onto their current strong growth rates for the next year or more. Information Technology is forecast to sustain double-digit EPS growth in the mid- to high-teen percentages through 2026. Utilities growth is forecast to moderate but only slightly while remaining above long-term average, aided by AI data center demand for electricity. Other sectors forecast to grow EPS above their long-term averages include Financial, Healthcare, Consumer Discretionary, and Consumer Staples. For 2025, we raised our forecast for S&P 500 earnings from continuing operations to $276, from $265. Our revised forecast models full-year EPS growth of 11.8%. For 2026, we raised our forecast for S&P 500 earnings from continuing operations to $307, from a preliminary outlook in the high $280s- low $290s range. Our revised forecast models full-year EPS growth of 11.2%. We are keeping in place for 2026 several of the above-average growth assumptions in our 2025 forecast, while moderating the overall growth outlook slightly. We expect the AI transformation to continue to drive growth in Communication Services, Information Technology, and Consumer Discretionary. We look for growth to slow in defensive sectors but potentially to pick up in Energy. Domestic and Global Markets Following a November in which the S&P 500 soared by almost 6%, the broad market index lost 2.5% in December, in what is normally its second-best month of the year. At the end of November 2024, many indices were at or near all-time highs. At the 11-month 2024 mark, the S&P 500 had delivered total return (with dividend) of 28.1%. By year-end, that gain had been cut to 25%. Nasdaq, which was up 28.9% at the end of November, finished the year up 29.6% on a total-return basis. Wilshire Large Cap Growth rose 37.8% in 2024 while expanding on its mid-teens percentage-point premium to Wilshire Large Cap Value. The Russell 2000 soared 11% in November to a 21.6% annual gain, driven by post-election enthusiasm toward domestic-facing companies. But it fell nearly as much following the Fed news, ending the year with a 13.6% gain. The DJIA also surrendered November gains and finished 2024 up 15% for the year. The Barclays Bloomberg U.S. Bond Index, which was up 4.5% year to date at the end of September, fell to up 2.2% at the end of November and finished 2024 with just a 0.9% gain. Following the December sell-off, we believe stocks can continue to rise from here, given positive fundamentals in GDP and earnings. Whereas the past three years were dominated by monetary policy, however, fiscal policy could have an outsized impact in 2025. Four sectors outperformed the S&P 500 in 2024. The three traditional growth sectors (Com
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