Another reset, but bull trend intact

What happened

After strong performance for most of 2024, equities have weakened over the past month. The recent softness in the equity market has coincided with a sharp reset higher in interest rates, as the 10-year U.S. Treasury yield has risen from about 4.15% to 4.78% since early December. 

The just-released December monthly jobs report was considerably stronger than expectations, clocking in at 256k jobs added relative to the consensus estimate of 165k. Consequently, the 10-year yield added to its recent gains, and the market expectations for Federal Reserve (Fed) rate cuts this year has been significantly curtailed. The market is now pricing in just one 0.25% rate cut in 2025, two fewer than was expected only a month ago.

Our Take

The weight of the evidence in our work suggests we are seeing a reset of market prices and sentiment, which had become stretched on a short-term basis, though it is still within the confines of an ongoing bull market.

Indeed, late in 2024, we saw record levels of investor optimism on some metrics, such as the percentage of investors expecting higher stock prices over the next year and record high equity allocation recommendations by short-term newsletter writers.

When expectations are high, a little bad news can go a long way. And the proximate cause of the recent market setback has been the sharp move higher in interest rates. Over the past few years, when the 10-year yield has risen above 4% and at an accelerated pace, this has challenged equity markets. It’s not a coincidence that the S&P 500’s recent peak on December 6 coincided with the trough for the 10-year U.S. Treasury yield.

That said, today’s rise in rates on the jobs report and the pullback in the market’s expectations around Fed rate cuts occurred on the back of strong economic data.

Our long-held view remains that we would prefer a stronger economy with fewer rate cuts than a weaker economy that requires more aggressive rate cuts. One only needs to look back to 2000 or 2008, where aggressive rate cuts did not stem bear markets or recessions.

While the sharp reset higher in interest rates relative to recent years provides competition to stocks, in many ways, we are simply reverting to the old norms seen prior to the Global Financial Crisis (GFC).

From 1950 to 2007, the 10-year U.S. Treasury yield averaged 6.2% and inflation 3.8%, even while the S&P 500 averaged an 11.9% average annual total return. 

A resilient economy should continue to support higher corporate profits, and the economy has proven to be somewhat less interest rate sensitive relative to history over recent years.

Our head of U.S. economics continues to expect GDP growth of around 2.5% in 2025. This should continue to power forward earnings estimates higher, a pillar of this bull market over recent years. That said, for the stock market to get back in gear to the upside, stabilization in rates will be key.

Our fixed income team expects that rate stabilization is not that far away, given the U.S. yield spread advantage to our G-7 peers is near the highest level since 2019 and foreign demand remains healthy.

Importantly, pullbacks are always uncomfortable but are the admission price to the market.

• Since coming out of the GFC in early March 2009, we count 30 previous declines of at least 5% for the S&P 500, a period from which the market has had a total return of 1087%.
• Although there has been wide variation, the median pullback has been 7.5% (average 10.2%) over 28 calendar days (average 49 day). This compares to the recent pullback of about 4% over 35 days.
• We are likely at least halfway through this current setback already. Moreover, we have also seen other areas of the markets, such as small caps, down about 10% and the average stock, as proxied by the S&P 500 Equal Weight Index, down 7%, suggesting a decent reset has already occurred.

Bottom Line

With our 2025 outlook A bull in a china shop, we discussed that while the primary market uptrend was intact, it would likely be a bumpier path higher with elevated investor expectations, wide policy uncertainty, and rising yields being risks.

The recent setback in markets has not altered our overarching view, and the data suggests we are at least halfway through the current corrective period in markets.

Thus, we would stick with the primary uptrend, and for those investors underweight their target equity position, we would use the pullback to average into the market.

• The U.S. remains our preferred region.
• Favor large caps followed by mid caps.
• Sector preferences include technology, communications services, and financials.
• We also still see benefits in holding a modest position in gold as a portfolio diversifier.