Natali_Mis/iStock by way of Getty Photos
By Michael Kagan and Stephen Rigo, CFA
Broad Bullishness Creates Extra Threat, Not Much less – 4Q 2024 Market Overview
A strong post-election rally propelled the S&P 500 Index up 2.4% within the fourth quarter, the S&P 500’s fifth consecutive quarterly advance (and eighth over the previous 9 quarters). The index’s 25% whole return for calendar 2024 marked back-to-back years of no less than 25% returns, an ascent solely achieved 4 instances since 1929 (1936, 1955, 1998, and as we speak). At this level, we’re working out of superlatives to explain the market’s relentless advance over the previous two years.
Shopper discretionary shares led the advance within the quarter (+14.3%), the one sector to put up a double-digit quarterly return. This was virtually completely pushed by Tesla (TSLA), which rose 52% as traders chased the open-ended optionality of an Elon Musk/Donald Trump alliance. Journey and client shares (together with Amazon (AMZN)) additionally fared nicely with traders optimistic that sturdy client spending would proceed past the vacation buying season. Communication providers and data know-how (IT) additionally outperformed on continued optimism round synthetic intelligence. Lastly, financials carried out nicely as traders seemed ahead to a lighter regulatory contact for banks and bank card issuers beneath a Republican administration.
“Investor expectations for lower interest rates remain too aggressive and could act as a ceiling to materially higher stock market returns.”
Supplies and well being care shares had been the worst-performing sectors within the quarter, declining -12.4% and -10.3%, respectively. Metals, mining and chemical substances shares lagged as the economic economic system stays sluggish and traders feared stubbornly excessive mortgage charges would hold a lid on actual property exercise. Inside well being care, massive managed care firms trailed as traders fretted in regards to the trade’s claims-paying practices following the tragic homicide of Brian Thompson, a UnitedHealth govt. Drug shares had been weak as anemic present progress collied with worries in regards to the potential influence RFK Jr. might have on the trade ought to he be appointed as head of Well being and Human Providers.
Liquidity, the first driver of bull and bear markets in our view, stays plentiful, with credit score spreads at 20-year lows suggesting little concern of a company credit score cycle. Financial institution mortgage officers — as measured by the Senior Mortgage Officer Opinion Survey (SLOOS) — are normalizing underwriting standards following the most important non-recessionary tightening in credit score requirements in survey historical past, a tailwind for credit score availability (Exhibit 1). Lastly, expectations for capital markets exercise (IPOs, debt issuance, M&A) are excessive as traders anticipate the Trump administration and Republican majority to reduce scrutiny on company deal making. Nonetheless, it isn’t all blue skies as we begin 2025. A year-end market swoon introduced a spike in volatility sending practically 80% of S&P 500 shares beneath their 50-day transferring common.
Exhibit 1: Credit score Availability Is Growing
As of December 31, 2024. Supply: ClearBridge Investments, Barclays Analysis and Federal Reserve.
Outlook
Though circumstances as we speak stay conducive for threat belongings, we see excessive expectations and sticky inflation as dangers to the 2025 outlook. As evidenced by the post-election rally, markets anticipate Trump’s insurance policies will unleash a capital funding cycle whereas technological innovation will drive an increase in productiveness. Nonetheless, inflation stays stubbornly shut to three%, versus the Fed’s 2% goal, whereas wage inflation stays above 4%. A knowledge-dependent Fed is probably going completed decreasing rates of interest given comparatively straightforward present monetary circumstances and GDP progress trending round 2.5%.
Rates of interest are a key medium-term threat, in our view. Investor expectations for decrease rates of interest stay too aggressive and will act as a ceiling to materially larger inventory market returns. We consider that actual rates of interest sooner or later usually tend to be in step with longer-term historic ranges, not the put up–World Monetary Disaster period to which many fairness traders are anchored (particularly contemplating the probability for larger deficit spending). Whereas fairness markets have been prepared to soak up larger low cost charges so far, the gradual acceptance of a “back to the future” fee regime, in addition to the indeterminable impact of future authorities coverage actions, will possible play a higher position in fairness returns in 2025.
Expectations of the influence generative AI can have on capital funding and financial progress stay sky excessive. Agentic AI, a sort of synthetic intelligence that may make choices autonomously with restricted human supervision, has changed copilots because the buzzword in Silicon Valley. Nonetheless, regardless of the altering terminology we see this as a “copilot 2.0” effectivity instrument extra akin to desk stakes for software program providers than a step perform monetization alternative. With America’s largest know-how firms dedicated to AI infrastructure capex, we stay targeted on investor willingness to fund this huge outlay within the absence of a tangible returns on investments. With energy prices and compute depth growing, the funding required to chase synthetic common intelligence (AGI), the flexibility of a machine to know or be taught any mental job {that a} human being can, continues to march larger. In our view, we stay many iterations away from having humanoid robots doing our cooking or cleansing or totally autonomous driving.
Regardless of sturdy GDP progress, there stay many anemic areas in our economic system, a dynamic we see as troublesome to enhance ought to charges stay at present ranges. Housing stays unaffordable (Exhibit 2) and with mortgage charges sticky at ~7% (Exhibit 3); it’s exhausting to see exercise pickup with out worth concessions or higher financing charges (or each). Manufacturing stays in a stoop with the ISM Manufacturing PMI highlighting contracting exercise in 25 of the previous 26 months. Ahead-looking demand indicators proceed to recommend sluggish exercise. Lastly, regardless of at the moment sturdy client spending and near-full employment, the rise in bank card delinquency charges must be monitored for client stress on the lower-end of the revenue curve.
Exhibit 2: House Affordability Is Low
As of December 31, 2024. Supply: ClearBridge Investments, Nationwide Affiliation of Realtors, Bloomberg Finance.
Exhibit 3: And Mortgage Charges Are Excessive
As of December 31, 2024. Supply: ClearBridge Investments, Bankrate.com, Bloomberg Finance.
In sum, we consider that the economic system will proceed its enlargement in 2025 pushed by incremental fiscal assist, productiveness good points and secure employment traits, with wage progress sustaining client spending. Nonetheless, we really feel the impact on financial progress that potential coverage modifications floated by the Trump administration can have — be they tax extensions, tariffs, immigration or a change in authorities dimension — are largely factored into as we speak’s market valuations. We do anticipate lowered regulatory scrutiny to unlock funding and drive an M&A upcycle, which might be constructive for capital markets, all else equal.
Shorter time period, we fear that present expectations have develop into too complacent or, stated extra plainly, too bullish. Whereas we agree the influence of generative AI is more likely to create game-changing applied sciences and alternatives for traders over the following decade, we really feel that this cohort of firms, which have been market leaders and the place expectations are sky excessive, might face some volatility whereas digesting current good points. In addition they face dangers from the fact of non-linear adoption charges for brand new applied sciences, altering enterprise fashions and unanticipated bottlenecks (significantly energy availability and price).
Our longer-term fear pertains to the sustainability of presidency debt and the burden of debt service on the price range deficit. In some unspecified time in the future the U.S. might want to enhance taxes or reduce spending to forestall debt prices from spiraling uncontrolled. Deficit spending at present ranges can not final endlessly. Present presidential plans supply an impractical price range that might tremendously enhance the deficit, an outlook that worries us additional. Ought to traders require a higher threat premium (yield) to personal a risk-free Treasury, the following administration and Congress will face stark selections not in anybody’s present playbook. On no account is the U.S. {dollars} standing as reserve foreign money our birthright.
Conclusion
Our expectation is that 2025 can be a extra subdued, however constructive, 12 months when it comes to general fairness returns, however we admit this isn’t a daring prediction given the surplus returns of the previous two years and the at the moment benign backdrop. General longer-term fundamentals stay on a stable footing. We anticipate small and mid cap firms, in addition to extra cyclical companies, to learn from continued progress of the U.S. economic system. We consider the present backdrop has heightened the danger to the funding panorama ought to there be any stall within the disinflationary development, disappointment in AI-driven capex, or authorities coverage hiccups. We consider when everyone seems to be bullish there may be extra threat to markets, not much less.
We’re long-term traders targeted on the risk-adjusted returns a diversified portfolio can ship by means of a market cycle. Moderately than attempting to wager on near-term earnings traits or authorities coverage hypothesis, we consider it’s higher to look out two to a few years and make funding choices based mostly upon our evaluation of an organization’s longer-term, sustainable progress fee relative to what’s implied in as we speak’s share worth.
Portfolio Highlights
The ClearBridge Appreciation Technique modestly underperformed the benchmark S&P 500 Index within the fourth quarter. On an absolute foundation, the Technique had constructive contributions from seven of 11 sectors. The IT and financials sectors had been the primary constructive contributors to efficiency, whereas well being care was the primary detractor.
In relative phrases, an obese to supplies and an underweight to client discretionary induced unfavourable sector allocation results to outweigh constructive inventory choice, which was pushed by sturdy choice within the industrials, vitality and supplies sectors. Choice in well being care detracted.
On a person inventory foundation, the largest contributors to absolute efficiency through the quarter had been Amazon.com, Broadcom (AVGO), Nvidia (NVDA), Apple (AAPL) and Visa (V). The largest detractors had been Eli Lilly (LLY), American Tower (AMT), Thermo Fisher Scientific (TMO), ASML (ASML) and Adobe (ADBE).
In the course of the quarter, we initiated new positions in BJ’s Wholesale Membership in client staples and Starbucks in client discretionary, and we exited Nestle in client staples, PPG Industries in supplies and ICON in well being care.
Michael Kagan, Managing Director, Portfolio Supervisor
Stephen Rigo, CFA, Managing Director, Portfolio Supervisor
Efficiency supply: Inside. Benchmark supply: Normal & Poor’s.
Click on to enlarge
Unique Put up
Editor’s Notice: The abstract bullets for this text had been chosen by Looking for Alpha editors.
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