ISG 2025 Market Outlook Commentary

ISG

February 4, 2025

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The stock market demonstrated remarkable strength throughout 2024, achieving multiple record highs and establishing a two-year bull market run.  U.S. stocks attracted unprecedented investor confidence, pulling in over $1 trillion since 2020.  The “Magnificent Seven” – Apple, Amazon, Google, Meta, Microsoft, Nvidia, and Tesla – technology giants played a pivotal role in this rally, surging over 50% while the remaining 493 stocks in the S&P 500 Index returned about 12%, highlighting the extraordinary influence of these mega-cap tech companies on overall market performance.¹

Artificial Intelligence (AI) emerged as a dominant market theme in 2024, driving strong returns across various sectors.  Nvidia, at the forefront of AI chip development, saw its stock soar about 170% in 2024. The AI boom’s impact extended beyond traditional tech companies, with Vistra Corp (VST), a utility company powering AI data centers, leading the S&P 500 Index with a remarkable 300% gain. 

Growth stocks dominated the market throughout 2024 significantly outperforming Value stocks.  The market showed remarkable stability with only a couple notable pullbacks indicating strong structural support and investor conviction.  While large-cap tech stocks led the market’s early gains, market participation broadened in the second half of the year.  Small-cap stocks, however, underperformed their larger peers amid concerns about economic growth and higher interest rates.  U.S. market outperformance was particularly notable against global peers, with international stocks (as measured by the MSCI EAFE Index) experiencing one of its worst years versus the S&P 500 Index, underperforming by close to 20%.  

In contrast to the strong equity performance, bond returns remained muted, with the Bloomberg Aggregate Bond Index returning just 1.3%.  Meanwhile, Bitcoin surged following Trump’s victory, driven by his pro-cryptocurrency stance and campaign promises, while gold rallied about 25% as government spending and deficits continue to rise.

Corporate earnings exceeded expectations throughout 2024, marking the fifth consecutive quarter of year-over-year earnings growth for stocks in the S&P 500 Index, with an expected growth rate of about 10% for the year.  The welcome decrease in inflation throughout 2024 while maintaining robust economic growth created an ideal “Goldilocks” scenario that supported equity valuations. However, market valuations have stretched well beyond historical norms.  Current price levels reflect exceptionally rosy expectations that may prove difficult to achieve. 

The Federal Reserve’s (Fed) pivot toward monetary easing emerged as a key market catalyst in 2024.  Following the end of its tightening campaign in late 2023, the Fed managed market expectations carefully throughout the year.  While investors initially anticipated aggressive rate cuts, the central bank maintained a measured approach due to above-target inflation and robust labor market conditions.  The Fed’s first rate cut in September 2024 marked a significant policy shift, though market expectations gradually adjusted to a slower, more deliberate easing cycle by October.  Markets demonstrated resilience to multiple significant geopolitical risks – Middle East conflicts, Ukraine war, U.S. elections, and Chinese economic challenges – suggesting strong underlying fundamentals.

Donald Trump’s return to the White House, accompanied by a Republican-controlled Congress, triggered significant market reactions.  Equity markets posted record rallies as investors anticipated the implications of potential policy changes, including tax cuts, deregulation, and shifts in trade policies.  However, this optimism was tempered by concerns over increased deficits, immigration policies, and the possibility of aggressive tariffs, particularly on Chinese imports.

The Recession That Never Materialized

Entering 2024, expectations for the market and economy were low.  In their 2024 outlook, J.P. Morgan projected a 25% chance for a U.S. recession by the first half of 2024, and 45% chance by the second half of 2024.  Goldman Sachs stated that the risk of a recession in 2024 was 30%.  Both institutions had little faith in the U.S. stock market; J.P. Morgan believed the S&P 500 would end the year at 4,200, with Goldman Sachs projecting 4,700.  No recession materialized, and the S&P 500 closed the year just shy of 6,000.²

Economic and market resilience was the name of the game in 2024.  Inflation trended towards the Fed’s 2% goal, the labor market remained balanced, and companies grew earnings above estimates.  The unemployment rate is at its long-term average and wage growth is above inflation, supporting consumer activity.  Market performance and economic activity beat almost all expectations that were held entering 2024.³

Inflation and the Labor Market

During 2024, the Consumer Price Index (CPI) averaged 2.96% y/y, and the Producer Price Index (PPI) averaged 2.19% y/y.  The Fed’s preferred inflation gauge, the Personal Consumption Expenditure Index (PCE), averaged 2.51% y/y.  All three inflation readings are close to where they began 2024, but they still fall short of the Fed’s 2% long-term target.

In December, Fed Chair Jerome Powell noted that the U.S. economy is in “a really good place”. But Powell also stated that he would like to see further progress on inflation as they think about further cuts. The Fed cut in three consecutive meetings to end 2024, with the Fed Funds Rate now at 4.25-4.50%, down from 5.25-5.50% at the start of 2024.

The labor market has cooled but remains balanced. Monthly job gains averaged 190K in 2024, with an average unemployment rate of 4% – both better than the 10-year averages (160K and 4.70%, respectively).

It appears that we are in a soft landing (i.e. Inflation and growth are slowing, yet still positive).  The Fed will continue to be cautious with rate cuts, remain attentive to data, and react quickly to any unexpected weakening in the economy.  The U.S. economy should remain robust in 2025.

2024 Asset Class Performance

Equity Markets

2024 marked another strong year for markets; the S&P 500 rose 25% following similar gains in 2023. The past two years marked the first instance since 1997-1998 of consecutive years with returns exceeding 20%.  Growth outperformed value by 20 percentage points.  Since the start of 2023, growth is up 89% while value is up 22%.  However, in the second half of 2024 market performance broadened with other areas of the market performing in line with Large-Cap growth companies.

Large-Cap U.S. companies once again dominated performance as Mid-Caps were up 14% and Small-Caps were up 9% for the year.  Developed International stocks also underperformance the U.S. up only 4% (as measured by the MSCI EAFE Index). ⁴

In portfolios, our focus and significant overweight in Large-Cap U.S. was very helpful to performance.  However, investments outside of this segment, such as Mid-Cap and International, generally underperformed in 2024.  Although diversification did not necessarily help year-end performance numbers during this short time frame, it remains a key tenet of our investment philosophy and we believe it will continue to serve portfolios well over time.

Fixed Income

High quality fixed income securities had modest overall performance with the Bloomberg Aggregate Bond Index up only 1.3% for the year.  Despite relatively high 5%+ yields on quality fixed income, rising interest rates drove bond prices down hampering total returns. 

High Yield Bonds, however, delivered an 8.2% return as these higher interest rates supported strong distribution yields.  Having credit exposure in our fixed income positions was generally favorable for performance.  We continue to balance the credit quality of our fixed income investments in an effort to maintain safety and stability while maximizing yields in portfolios.⁵

Alternatives

Compared to institutional investors, individual investors have historically been under-allocated to alternative investments.  The average individual investor allocates 3% to alternative investments, whereas endowments allocate 57%.  Research has shown that adding alternatives to a diversified portfolio improves return while lowering volatility.  Private markets provide investment opportunities in sectors of the economy that are difficult to gain exposure to in public markets.⁶

Our main focus in Alternative investments is in the private markets.  Private Credit and Private Real Estate have been staples in our portfolios for years, while private equity is a newer area of focus.  Going forward, we continue to research other areas of opportunity, such as Private Infrastructure, as data centers and alternative power generation continue to gain traction.

In 2024, Private Credit delivered above expectations with a return of over 12% for our main investment in the Cliffwater Corporate Lending Fund.  High interest rates and a strong economy (i.e. low default rates) helped performance and supported favorable distribution yields.

Returns in Private Real Estate continued to underwhelm as interest rates remained high and commercial real estate valuations remained relatively low.  Multi-family apartments and Industrial warehouses (which represent the majority of our RE investments) generally performed very well with high occupancy and growing rent rates.  However, total returns did not reflect the fundamentals as valuations and real estate activity remained muted.

We have trimmed our Real Estate exposure over the past couple of years in favor of higher yielding investments, such as Private Credit, however, we are optimistic on Real Estate going forward.  Its stable tax-efficient yields, strong fundamentals (in most segments) and potentially declining interest rates at some point all support a favorable longer-term outlook.

Finally, Private Equity (PE) is newer addition to our allocations for certain portfolios.  Historically, PE has delivered higher returns with lower risk (volatility) than the public equity markets, and this is why most endowments and large institutions have invested in it for so long.  More recently, PE firms have developed funds that make PE accessible to individual investors meeting certain accreditation requirements.  Our main PE fund, the Cascade Private Capital Fund, returned close to 35% in 2024.  Stay tuned for more information on PE as we move forward in 2025.

Conclusion

The 2025 U.S. market outlook is complex, shaped by the powerful interaction of economic resilience, strong corporate earnings, elevated valuations, transformative administration policies, and uncertainty surrounding the Federal Reserve’s monetary stance.

President Trump’s ambitious agenda, which includes tariffs, deregulation, spending cuts, tax reductions, and restrictive immigration policies, presents both significant opportunities and risks for investors. The U.S. economy’s shift back to mid-cycle characteristics provides a favorable backdrop, particularly for cyclical sectors.

Ultimately, while the 2025 market path is likely to be complex, it is also full of potential.  Favorable economic conditions and strong corporate earnings projections provide optimism, while high valuations in the equity markets warrant some caution.  As always, we attempt to build well diversified, durable portfolios that can withstand the normal day-to-day volatility of the markets while taking advantage of the longer-term opportunities they provide.

We sincerely appreciate the trust you place in us.  If you have any questions or would like to discuss anything in more detail, please do not hesitate to call your Advisor.

Sincerely,

Your Team at ISG

Sources: Hightower Investment Solutions: 2024 Market Recap and 2025 Outlook James Investment Research: Economic Outlook 2025 ¹ Magnificent Seven – https://www.investopedia.com/magnificent-seven-stocks-8402262 ² FactSet as of 12/31/2024. JP Morgan as of 12/31/2024.  Goldman Sachs as of 11/21/2023. Hightower Investment Solutions: 2024 Market Recap and 2025 Outlook, January 2025. ³ FactSet as of 12/31/2024. JP Morgan as of 12/31/2024.  Goldman Sachs as of 11/21/2023. Hightower Investment Solutions: 2024 Market Recap and 2025 Outlook, January 2025. ⁴ FactSet as of 12/31/2024. Hightower Investment Solutions: 2024 Market Recap and 2025 Outlook, January 2025. ⁵ Charles Schwab Chart Book Q1 2025.  Bloomberg as of 12/31/2024. ⁶ Blackstone as of September 2024.  Hightower Investment Solutions: 2024 Market Recap and 2025 Outlook January 2025.

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