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Market analysis
December 16, 2024
Number of the week:
21
The number of times in the past 98 years the S&P 500 has posted total returns more than 28.6%, the index’s 2024 return through Friday.
Term of the week:
Valuation
The analytical process of determining the current (or projected) worth of an asset or a company. There are many techniques used for doing a valuation. An analyst placing a value on a company looks at the business's management, the composition of its capital structure, the prospect of future earnings and the market value of its assets, among other metrics.
Quote of the week:
The National Federation of Independent Business Small Business Optimism Index jumped to 101.7 in November, its highest since June 2021. This broke a 34-month streak of readings below the 50-year average of 98.0. Small business owners anticipate a post-election shift in economic policy to lower costs and ease taxes and regulations.
― Robert Haworth, CFA, Senior Vice President, Senior Investment Strategy Director, U.S. Bank
Global economy
Quick take: U.S. inflation firmed on increases for food and energy, while small business sentiment improved. The naming of a new French Prime Minister eased some current concerns, but investor sentiment is still challenged.
Our view: Growth in the United States and India remains exceptional while other major economies, including China, Europe, Japan and the United Kingdom, demonstrate modest but positive economic expansion despite elevated interest rates. Slowing growth and inflation trends are likely to persist well into 2025 due to lagged effects of high borrowing costs.
- U.S. inflation rose in November, with the Consumer Price Index up 2.7% year-over-year compared to 2.6% in October and producer prices increasing 3%, also from 2.6%. Food prices were the primary contributors to recent gains, with modest gains also for energy after several months of declines. Core components saw slight gains; slowing in housing was the primary detractor. Easing in shelter costs indicate the trend should be slower for inflation in the months ahead, though recent commodity price gains are concerning.
- The National Federation of Independent Business Small Business Optimism Index jumped to 101.7 in November, its highest since June 2021. This broke a 34-month streak of readings below the 50-year average of 98.0. Small business owners anticipate a post-election shift in economic policy to lower costs and ease taxes and regulations.
- French President Macron named Francois Bayrou Prime Minister, the fourth for France in 2024. Bayrou faces the challenge of building consensus in a deeply divided parliament. The primary task is to rein in the deficit, expected to reach 6% of gross domestic product (GDP) at year end. Moody’s downgraded France’s credit rating one notch amid the uncertainty to Aa3 from Aa2.
- Chinese officials endorsed a more proactive fiscal policy, an increase in debt issuance and a looser monetary policy, according to the state media’s summary of the Central Economic Work conference. This would include tolerance of a higher deficit-to-GDP ratio to make policies more impactful and specific required reserve ratio cuts to ensure ample liquidity. The goal is to increase incomes and boost consumption to support the economy. The lack of details and current actions left markets somewhat skeptical the measures are sufficient to meet economic growth goals.
Equity markets
Quick take: Year-to-date performance of U.S. equities remains superb and broad based while December performance lags.
Our view: The fundamental backdrop remains supportive of a risk-on (aggressive) bias. Inflation is waning, interest rate cuts are in motion and earnings are trending higher, all of which bolster sentiment.
- Year-to-date performance is superb and broad based. The S&P 500 ended last week up 28.6% for the year, including dividends, with all 11 sectors positive, six of which are up more than 20%, bolstered by underlying economic strength and positive investor sentiment. The S&P 500 has posted total returns above 28.6% in only 21 of the past 98 years.
- December performance is muted, partially due to profit taking following strong year-to-date performance, elevated valuations, persistent inflation and uncertainty around new Washington administration-related policies. As of Friday’s close, the S&P 500 is up a modest 0.4% in December, with eight of 11 sectors in negative territory.
- Consensus earnings projections reflect optimism, but valuations are elevated. Analysts forecast S&P 500 earnings of approximately $240 per share for full-year 2024 and $273 for 2025, according to Bloomberg, FactSet and S&P Cap IQ, reflecting respective 8.8% and 13.5% year-over-year growth. At current price levels, the S&P 500 trades at approximately 25 times the 2024 estimate and 22 times 2025 projections, at the high side of its 35-year historical average, though short of extremes. Company guidance following fourth quarter releases, beginning in mid-January, should improve earnings visibility for 2025.
- Opportunities exist in all market environments; we favor balanced exposure to the technology-oriented growth sectors and income-oriented alternatives. The world is experiencing a rate of change that has never been faster, and speed, scale and efficiencies do not occur without technology. This presents favorable conditions for artificial intelligence-related buildout beneficiaries. Similarly, defensive/income-oriented sectors such as Real Estate, Utilities, Consumer Staples, Industrials and select Healthcare should continue to respond favorably to the Federal Reserve’s (Fed) less restrictive policy stance; lower Treasury yields reduce competition from bonds for dividend-paying securities. In aggregate, a balanced approach combining growth-oriented technology and defensive sectors provides exposure to evolving technologies while capitalizing on favorable risk profiles of sectors and companies during periods of economic uncertainty and a lower interest rate environment.
Bond markets
Quick take: Rising Treasury yields weighed on bond returns last week. High-quality bond prices, such as Treasuries and investment-grade corporate and municipal bonds, fell 1% to 2%. Investor focus is on the Federal Reserve, with consensus expectations for a 0.25% interest rate cut this week.
Our view: Core exposures to investment-grade bonds remains important to diversify portfolios, while incremental allocations to non-agency mortgages, collateralized loan obligations and riskier high yield bonds take advantage of compelling income generation opportunities.
- The European Central Bank (ECB) and Bank of Canada (BoC) kicked off another round of central bank interest rate cuts last week. The ECB cut rates 0.25%, its fourth cut this year while the BoC cut 0.50%, its fifth this year. Rate cuts are expected to continue this week, with the Fed expected to cut 0.25%. Investors anticipate additional cuts in 2025 across many developed markets, including the U.S., Europe and the United Kingdom. The global unwind of restrictive rate settings should remain a tailwind for riskier assets like stocks.
- Fed officials will update their expectations for rates, economic growth and inflation at Wednesday’s meeting. The Fed last published officials’ projections in September, when the median official expected four cuts in 2025 to bring the policy rate down to 3.25% to 3.50%. Bond yields have since increased to incorporate slower rate cutting expectations. The readjustment follows Fed communication for gradual policy adjustments ahead, but the formal update on Fed officials’ expectations will provide critical insight into the pace and magnitude of potential future cuts.
- Stable financial conditions enable businesses and municipalities to issue debt. While Treasury yields remain elevated relative to the prior decade, low incremental spreads on corporate and municipal bonds over Treasuries help contain borrowing costs for issuers. Borrowers increased their corporate and municipal bond issuance to take advantage of stable financial conditions, reshape balance sheets and push out debt maturities. Our analysis shows high yield corporate debt refinancing risk has fallen in recent months to more normal levels, which could portend falling default rates. High yield corporate bonds offer yields around 7%, a material improvement from investment-grade corporate bond yields around 5%. High yield municipal bond tax-equivalent yields are a compelling 9% and investment-grade municipal bond tax-equivalent yields are still meaningful, around 6%, assuming top federal tax rates.
Real assets
Quick take: Publicly traded real estate stocks dropped around 2% last week. While publicly traded real estate generates meaningful income, Treasuries offer competitive yields, which can weigh on investor appetite.
Our view: Real assets provide important sensitivity to growth and inflation in portfolios. Income on real estate has grown at a steady clip this year and fundamentals in most property types are solid.
- Real estate valuations are somewhat elevated, but exposures still generate meaningful income. After accounting for expenses, interest payments and taxes, publicly traded real estate generated a 3% increase in net operating income year-over-year in the third quarter. Industrial properties remain a source of strength, with net operating incomes up on average near 7% from a year prior. Occupancy rates are healthy, with industrial, apartment and retail properties averaging at least 95% occupancy. Office occupancy has fallen to 86% and income from office real estate has decreased, but office accounts for less than 4% of the publicly traded real estate market. Elevated valuations reflect the fundamental strength in most publicly traded real estate segments, heightening the importance for economic activity to meet economists’ forecasts for a modest expansion in 2025.
- Commodity prices rebounded last week, but opportunities depend on upside surprises in growth and inflation. Broad commodity exposures returned more than 1% last week, led by oil prices rising more than 5% and natural gas prices increasing around 2%. Despite the price increases last week, broad commodity exposures have lagged other real asset categories this year. Going forward, opportunities in commodities hinge on price appreciation stemming from growth surprises that increase commodity demand or supply constraints driving prices higher. Economists forecast inflation globally will slow in 2025 to less than half the rate of inflation in 2022 that supported double-digit commodity returns, but commodities can help protect against the risk of inflation surpassing expectations.
Based on our strategic approach to creating diversified portfolios, guidelines are in place concerning the construction of portfolios and how investments should be allocated to specific asset classes based on client goals, objectives and tolerance for risk. Not all recommended asset classes will be suitable for every portfolio. Diversification and asset allocation do not guarantee returns or protect against losses.
Past performance is no guarantee of future results. All performance data, while obtained from sources deemed to be reliable, are not guaranteed for accuracy. Indexes shown are unmanaged and are not available for direct investment. The S&P 500 Index consists of 500 widely traded stocks that are considered to represent the performance of the U.S. stock market in general. The Consumer Price Index is a measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food and medical care. It is one of the most frequently used statistics for identifying periods of inflation or deflation. The National Federation of Independent Business Small Business Optimism Index is a composite of 10 seasonally adjusted components. It provides an indication of the health of small businesses in the U.S., which account for roughly 50% of the nation's private workforce.
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