2024 began with a consensus outlook on the economy and financial markets that could be best termed muted optimism. That viewed proved that crystal balls are at best cloudy and often downright useless. There were fears that the downdraft in growth experienced in the first half of 2022 would be repeated. Those fears appeared justified. The 2-yr/10-yr U.S. Treasury yield curve, long a dependable predictor of coming recession, had been inverted (the 2-yr yield higher than the 10-yr yield) for 17 consecutive months. The Conference Board’s Index of Leading Economic Indicators had been in free fall for a similar period. The Fed’s target rate and U.S. real yields were at generational highs. Inflation, while well below its 2022 peak was still at problematic levels.
Pushing against these headwinds were a few secular trends. Fiscal support remained elevated with the Federal budget deficit around 6%, a level formerly reached only during deep recessions rather than three years into an economic expansion. Consumers were mostly in a buoyant mood due to the strong job market, growing wages and strong household balance sheets. In the corporate world, a capex boom powered by spending on Artificial Intelligence (AI) and the shortening of supply chains provided support to earnings. Finally, there was near surety that inflation was defeated, and the Fed would be cutting rates aggressively to support the economy. The consensus expectation was for six such rate cuts in 2024. The hope was that the Fed could engineer a soft landing where inflation fell but economic growth held up.
The outlook for financial markets was also cautious. Corporate earnings were expected to grow at a solid clip. Fixed income markets were expected to do well as interest rates would surely fall in concert with Fed rate cuts. Equities were likely to benefit from earnings growth and a broadening of performance beyond the Magnificent 7. A repeat of the 26% total return on the S&P 500 in 2023, which undid all of 2022’s losses was not probable, but a more normal upper single-digit return seemed a reasonable expectation.
The economy surprised to the upside for most of the year. After sluggish 1Q24 GDP growth of 1.6%, the economy reeled off two consecutive quarters of growth above 3%. Fourth quarter 2024 GDP came in at 2.3%. Fiscal policy remained an important contributor to growth with both federal and state and municipal spending advancing. Consumer spending remained healthy while investment, in the form of corporate structures, equipment and intellectual property, strengthened.
As the year progressed, it became clear that while the economy remained quite healthy overall, there were strong crosscurrents under the surface. Supported by lingering excess cash from the pandemic, growing incomes and surging values of both their equity and residential real estate holdings, the top 25% or so of the income spectrum spent with abandon. Those in the bottom 25%, with their excess pandemic savings used up, modest if any real estate or equity market wealth and burdened by the impacts of two years of high inflation, struggled to make ends meet.
Similarly, the services sector of the economy abounded while the manufacturing sector limped along by comparison. Services benefitted from conspicuous consumption as consumers continued to pursue the experiences denied them during the pandemic. Health care boomed as well as many, especially seniors, who avoided interacting with the healthcare system during the pandemic again sought care. Manufacturing was restrained by the ongoing hangover from excess goods purchases during the pandemic. China’s emphasis on ramping up goods exports to offset a weak domestic economy also likely hurt U.S. manufacturers.
The expected six Fed rate cuts were whittled down to three, although the first cut in September was the deepest at 0.5%. As the year ended, many Fed Open Market Committee members expressed a preference for a more cautious approach to rate cuts in 2025.
Financial markets ended up being broadly positive in 2024. Equities defied muted expectations with the S&P 500 delivering a second consecutive year of 20%+ total returns. Equity returns continued to be lopsided with the tech-heavy NASDAQ 100 delivering a total return of nearly 26% and the Magnificent 7 posting a total return of nearly 67% after returning more than 100% in 2023. Nvidia (NVDA) was a standout performer as it rode the AI wave in producing a 171% price return and saw its market capitalization advance from $1.2 trillion to more than $3.3 trillion. Returns outside of the mega-cap tech arena were positive but more pedestrian. The equally weighted S&P 500 returned just under 13%, the S&P 400 mid-cap index rose almost 14% and the Russell 2000 small-cap index managed a gain of almost 8%. Non-U.S. stocks delivered a blended total return of around 6% with emerging markets outpacing developed markets.
Bonds managed modestly positive returns for the year despite interest rates defying expectations. The Bloomberg U.S. Aggregate bond index produced a total return of 1.25% in 2024. Despite positive returns last year, long-term bond investors are still struggling and have compounded losses in the Bloomberg Aggregate Index at 0.3% per year over the past five years.
