January 2025
Market Update

Key Updates on the Economy & Markets

There was no shortage of market-moving events as we closed out the year. The outcome of the presidential election triggered a broad rally in the stock market in November, but the rally faded as the year ended, although the S&P 500 trades only a few percentage points below its all-time high. The credit market was equally active at the end of the year, with the Federal Reserve cutting rates by another -0.50%. However, the major development was the changing 2025 outlook. The Fed and the market both now expect fewer rate cuts in 2025 compared to the end of Q3, which resulted in a sharp rise in Treasury yields. This letter recaps the 2024 stock market rally, provides an update on the economy and the Fed’s rate-cutting cycle, and looks ahead to 2025.

Looking Back on the 2024 Stock Market Rally

The past two years have been remarkable for investors, with the S&P 500 delivering strong returns in back-to-back years. Let’s take a closer look at the stock market’s rally in 2024, a year in which the S&P 500 set more than 55 new all-time highs. Figure 1 graphs the S&P 500’s return for each calendar year since 1980 and shows that the index posted gains of over +20% in 2023 and 2024. It marked the first time since the 4-year stretch from 1995 to 1998, and like the late 1990s, large-cap technology stocks played a major role in the S&P 500’s gains.

Figure 1:

Figure 2 shows the 2024 price returns of seven ETFs, each reflecting exposure to companies of different market cap sizes. The chart reveals a significant gap between the returns of large-cap and small-cap stocks in 2024. The top bar tracks the Magnificent 7, a group that includes Microsoft, Apple, Alphabet, Meta, Amazon, Nvidia, and Tesla. These seven companies, which now account for more than 33% of the S&P 500, returned over +60%. When the group expands from the Magnificent 7 to the 50 largest S&P 500 stocks, the return falls to +32%, still impressive but around half of the Magnificent 7’s return. Broadening the group further to include all S&P 500 companies reduces the index return to approximately +23%, and weighting companies equally rather than by market capitalization lowers the return to +11%.

Figure 2

The key takeaway is that the largest companies contributed a significant portion of the S&P 500’s return in 2024. Smaller companies delivered solid returns around +10%, but they underperformed on a relative basis. Mid-cap stocks returned +12%, while small-cap and micro-cap stocks returned +10% and +12%, respectively.

The concentrated stock market rally, which was driven by the outperformance of the largest companies, led to an unusual outcome. Figure 3 tracks the percentage of S&P 500 companies that outperformed the index during each calendar year. For the second consecutive year, fewer than 30% of S&P 500 companies beat the index in 2024. This is significantly below the average of 49% since 2000 and highlights the dominance of the largest companies in 2024.

Figure 3

Data Highlights the U.S. Economy’s Resiliency

The U.S. economy has consistently defied expectations of a slowdown since the Fed started raising interest rates in March 2022. Economists and market participants initially expected growth to slow as the Fed raised interest rates. However, it has now been nearly three years since the Fed’s first rate hike, and the economy continues to grow at an above-trend rate. While higher rates have slowed housing demand and weighed on business investment, the U.S. economy has managed to defy expectations with solid GDP growth. Figure 4 shows the U.S. economy grew at a +3.1% annualized pace in 3Q24, marking the third quarter in the past four with growth above +3%.

Figure 4

The next two charts show key drivers of economic growth since early 2022. Figure 5 tracks the contribution of personal consumption expenditures (i.e., consumer spending) to U.S. GDP growth. Despite high interest rates, consumer spending has remained a steady driver of growth in recent quarters. Multiple factors have increased household net worth and bolstered consumers’ financial strength, including record-high stock prices, rising home values, and solid wage growth. Additionally, many borrowers locked in low interest rates during the pandemic, which has made the U.S. economy less sensitive to rising interest rates this cycle.

Figure 5

Figure 6 shows the surge in manufacturing-related construction in recent years. For a long time, manufacturing construction was relatively modest, as most activity was outsourced to China, Mexico, and elsewhere. However, that changed in late 2021, around the time Congress passed trillions in new spending on infrastructure, green energy, and subsidies to incentivize U.S. manufacturing. These spending bills have been extremely supportive of the U.S. economy and created a boom in the manufacturing of semiconductors, electric vehicles, batteries, and solar panels. The result is a surge in manufacturing-related construction, the largest on record, as companies build new warehouses, industrial facilities, and semiconductor plants. The artificial intelligence industry’s emergence has provided another catalyst, as companies like Microsoft, Amazon, and Meta spend billions on data centers, information processing equipment like semiconductors, and energy production to meet growing power demand.

Figure 6

Economic growth is forecast to slow but remain solid next year, driven by the Trump administration’s pro-growth policies. The new administration’s policy agenda focuses on extending the 2017 tax cuts, reducing regulations across industries, and boosting domestic manufacturing through targeted incentives. These measures have the potential to stimulate capital expenditures, expand manufacturing capacity, and attract foreign investment to the U.S.

An Update on the Fed’s Interest Rate-Cutting Cycle

The Fed continued its rate-cutting cycle in Q4, lowering interest rates by -0.25% at both the November and December meetings for a total of -0.50%. The two -0.25% rate cuts were well telegraphed by the Fed and widely expected, but the big development in Q4 was the changing outlook for 2025. Despite the two rate cuts, Fed Chair Jerome Powell and other Fed presidents indicated they are not in a hurry to cut rates further. The change in tone follows the U.S. economy’s recent strength, which has caused the Fed to re-examine the need for additional rate cuts.

Recent economic strength has also led the market to re-evaluate its rate cut forecast. This dynamic can be seen in the bond market, where longer-maturity Treasury yields have risen sharply since the first rate cut in September. Figure 7 graphs the 10-year Treasury yield against the federal funds rate, which is the interest rate the Fed adjusts to set monetary policy. Since the first rate cut in September, the federal funds rate has decreased by -1.00%. While the Fed controls shorter-maturity interest rates, the market has more control over longer-maturity interest rates. Over the same period, the 10-year Treasury yield has had the opposite reaction: rising by nearly +1.00%.

Figure 7: 10-Year Treasury Yield vs Federal Funds Rate

What caused Treasury yields to rise as the Fed cut interest rates? Two key data points contributed to the Fed’s decision to start cutting rates in September: falling inflation and rising unemployment. Inflation declined from 3.3% in July 2023 to 2.6% in August 2024, while unemployment rose from 3.5% to a high of 4.3%. The two trends caused the Fed to shift its focus from lowering inflation to supporting the labor market. However, since the Fed started cutting, the trends have reversed. Inflation progress has stalled since September, and unemployment has declined to 4.2%. Heading into 2025, the Fed and the market have similar rate cut expectations: approximately -0.50% in cuts for the entire year. The question is whether they are placing too much emphasis on recent trends and underestimating the need for rate cuts. As both the Fed and the market saw in 2024, forecasting Fed policy is difficult, especially this cycle.

 Summary of Market Returns

Stock Market Recap – Stocks Deliver Significant Growth

In 2024, the stock market experienced significant growth, with the S&P 500 rising +24.89%.  This growth was primarily driven by large-cap technology companies, particularly those involved in artificial intelligence.  However, smaller companies underperformed, with the Russell 2000 Index gaining +11.39% but surrendering most of its post-election gains by year-end.

Internationally, U.S. stocks outpaced their global counterparts. The MSCI Emerging Markets Index returned 10.58%, while the MSCI EAFE Index, representing developed markets, gained 3.51%, both lagging behind the S&P 500. This underperformance was due to currency headwinds from a stronger U.S. dollar and the dominance of U.S. mega-cap stocks. Looking ahead to 2025, the potential implementation of tariffs by the Trump administration introduces significant uncertainty for international markets.

Bond Market Recap – High Quality Bonds Struggle as Long-Term Interest Rates Rise

The key theme that shaped the bond market throughout 2024 was the sharp rise in the 10-year Treasury which weighed down parts of the bond market with any sort of duration, or the sensitivity of a bond’s price to interest rate movements. The Aggregate Bond Index made up of higher-quality bonds such as U.S. Treasuries, corporate investment-grade, and mortgage-backed securities returned 1.31% as rising yields had a bigger impact on their longer maturities.  In contrast, with economic growth and corporate fundamentals remaining solid, High-yield corporate bonds outperformed returning 7.70% due to their lower sensitivity to rising interest rates and higher absolute yields. 

2025 Outlook – Key Themes to Watch

The S&P 500’s steady climb in 2024 reflects the market’s growing confidence. Investors are optimistic about the artificial intelligence industry’s growth potential. The U.S. economy outperformed expectations, growing at an above-trend rate in three of the past four quarters despite high interest rates. The stock market rally intensified after the election in November, as investors focused on the incoming administration’s policy agenda. Expectations for tax cuts, deregulation, and energy production are fueling hopes for stronger economic growth. The bond market echoes the equity market’s confidence, and corporate high-yield credit spreads are near their lowest levels in over 15 years.

However, the equity market rally has made broad market indices like the S&P 500 more concentrated and more expensive. The question on many minds is whether the momentum can continue in 2025. The S&P 500 currently trades at nearly 22x times its next 12-month earnings estimate, a level not seen outside of periods like the late-1990s tech boom and the recent post-COVID recovery, when interest rates were near zero. Investors have shown a willingness to pay higher multiples, but with valuations now at extremes, earnings growth will likely play an important role in determining the stock market’s path in 2025.   

Figure 8 tracks the current bull market, which started in October 2022 and is now in its third year. The current bull market has performed in line with historical norms, but the chart shows that returns often moderate as bull markets mature. This suggests that the market’s focus could shift to fundamentals and earnings as the next catalyst to push markets higher. 2025 is shaping up to be a year where companies will need to deliver on investors’ expectations to justify their high valuations.

 Figure 8: S&P 500 Returns During Bull Markets

Current Positioning

In 2024, our equity models focused on U.S. large-cap stocks, aligning with prevailing market trends that contributed to the strong performance of our stock strategies.  This focus reflects a pattern we’ve observed over the past several years, and we remain committed to monitoring market conditions closely and adjusting as needed. 

Turning to bonds, our Total Return Bond Strategy had an exceptionally strong year relative to the Aggregate Bond Index.  By favoring bank loans in this strategy, we experienced less volatility, attractive yields, and lower interest rate risk throughout the year. While this approach involves certain tradeoffs, we are actively monitoring the bond market and current holdings and will adapt our holdings as market conditions evolve in 2025.

As always, if you have questions about your risk level, please reach out and schedule a meeting so we can discuss this further.  We appreciate the trust and confidence you’ve placed in Copperwynd Financial, and we look forward to working with you throughout the year.

If you have any questions, please do not hesitate to contact our office at 480-348-2100.

FINANCIAL PLANNING
401(K) ALLOCATION

To download the January 2025 Newsletter: CLICK HERE

Copperwynd Financial, LLC is a registered investment adviser. Advisory services are only offered to clients or prospective clients where Copperwynd Financial, LLC and its representatives are properly licensed or exempt from licensure. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may be rendered by Copperwynd Financial, LLC unless a client service agreement is in place.

Copperwynd Financial, LLC provides links for your convenience to websites produced by other providers of industry related material. Accessing websites through links directs you away from our website. Users who gain access to third party websites may be subject to the copyright and other restrictions on use imposed by those providers and assume responsibility and risk from use of those websites.

This commentary reflects the personal opinions, viewpoints and analyses of the Copperwynd Financial, LLC employees providing such comments and should not be regarded as a description of advisory services provided by Copperwynd Financial, LLC or performance returns of any Copperwynd Financial, LLC client. Investments in securities involve the risk of loss. Past performance is no guarantee of future returns.

The S&P 500 Index or the Standard & Poor’s 500 Index is a market-capitalization-weighted index of the 500 largest U.S. publicly traded companies. The S&P 500 is a float-weighted index, meaning company market capitalizations are adjusted by the number of shares available for public trading. Note: Investors cannot invest directly in an index. These unmanaged indices do not reflect management fees and transaction costs that are associated with most investments.