2024 – AI dominance and U.S. exceptionalism

Every bull market tends to have a theme. The dominant theme of the bull market that kicked off in October of 2022—one month prior to the launch of ChatGPT—is Artificial Intelligence.

And, after a strong 2023, tech-related stocks helped to power the S&P 500 once again to a 25% return in 2024, its second consecutive annual gain of more than 20%.

The Magnificent 7, the term coined to describe a group of influential mega cap growth stocks, gained 48% alone over the past year. Yet, with a return of 16%, the other 493 stocks had better-than-typical market returns.

Still, the strength in mega cap growth stocks was a key driver behind the widest outperformance period of U.S. stocks relative to international developed markets since 1997.

Likewise, with less tech exposure, weaker earnings trends, and more sensitivity to higher interest rates, small caps trailed large caps by the greatest margin since 1998.

The U.S. economic exceptionalism also continued to dominate the global stage and support stronger domestic profits. Indeed, while most countries saw middling to deteriorating economic trends, the U.S. surprised sharply to the upside.

The current estimated GDP growth for 2024 stands at 2.7%, up from only about 1% expected by the consensus entering the year. The consumer, in aggregate, once again proved resilient and the overall economy less rate sensitive relative to history.

That said, while the full year was strong, stocks finished 2024 on a softer note as the post-election rally fizzled, market breadth weakened, and the fabled Santa Claus rally failed to materialize.

Although the S&P 500 finished the year only about 3% below its late-year peak, small caps were down 9%, and the equal-weighted S&P 500, a proxy for the average large cap stock, was off 6%.

Deteriorating market participation is a negative sign that bears watching, yet the recent pullback has reset some of the excess investor sentiment and an elevated bar for positive surprises.

Part of this equity softness occurred as the 10-year U.S. Treasury yield rebounded sharply, almost 50 basis points from early December, on the back of a more hawkish Federal Reserve, alongside wider policy uncertainty, and fiscal imbalances that continue to grow.

Stabilization in interest rates remain important for the continuation of the bull market given elevated equity valuations. Still, the primary equity market uptrend remains intact.

2025 outlook – A bull in a china shop

As discussed in our previously released 2025 outlook, we balance optimism about the ongoing economic expansion and the likelihood of further stock market gains in the new year with a keen awareness of potential disruptions.

The weight of the evidence suggests the primary market trend remains higher, driven by a resilient economy supporting solid earnings growth near 10% in 2025. Yet, investors should anticipate a bumpier path relative to last year, which should provide tactical opportunities.

• We expect steady growth on shifting ground for the U.S. economy which should remain the shining country on the global stage. The expansion will turn five early in 2025, and the evidence suggests we are in a mid-cycle transition with expected growth near 2.5%.
• Although the current market uptrend is mature, eight of the 10 previous bull markets have been stronger and longer than the current one. Notably, the S&P 500 has risen in 33 of the past 40 years, or 83%, which also favors seeing further gains in 2025.
• The November market pop was driven in part on the perceived market-friendly policy aspects of the incoming administration, such as deregulation and tax-extensions, followed by a December market pullback, driven by policy uncertainty and interest rate volatility. This is a microcosm of what we anticipate in 2025.

Positioning for growth amid complexity

From a global asset allocation perspective, we enter 2025 maintaining our equity bias and our long-standing preference for U.S. stocks relative to international.

• We retain our U.S. large cap preference given strong fundamental and earnings trends, followed by mid caps, which should benefit from pro-growth economic policies and attractive relative valuations.
• Our tactical sector preferences, which tend to be shorter term in nature, continue to be technology, communication services, and financials.
• Tech profit trends remain superior relative to the overall market, and price returns remain far from bubble territory, though concentration is a key risk. Financials should benefit from pro-growth policies, deregulation, and a rise in mergers and acquisitions.
• International market underperformance is at an extreme, amplified by the U.S. election, yet we remain underweight. There are potential catalysts, such as follow through on China stimulus, easing Ukraine-Russia tensions, and a weaker dollar. While these developments could trigger bounces in the international markets, the primary trend remains in favor of the U.S.
• We stay tilted to high quality bonds as yields remain elevated relative to the past two decades. We patiently seek a better tactical opportunity to upgrade credit, where valuations are rich.
• Alternatives should also help qualified investors navigate markets and embrace wider outcomes.
• Hedge funds are likely to offer opportunities amid global crosscurrents and asset class return dispersion.
• Private markets should benefit against the backdrop of lower yields and a pickup in mergers and acquisitions, improved business sentiment, and deregulation.
• We still find value in holding a modest gold position as a portfolio diversifier.

As always, we will continue to follow the weight of the evidence and keep you informed as our views evolve.

We balance optimism about the ongoing economic expansion and the likelihood of further stock market gains in the new year with a keen awareness of potential disruptions.