Shareholder Resources

A Strong Close to 2024

In November, the S&P 500 posted its largest monthly gain of the year, advancing 5.9% on the back of decisive clarity following the U.S. presidential election. Markets welcomed the prospect of a business-friendly administration with policies aimed at deregulation and potentially lower corporate taxes. Small-cap stocks outperformed, with the Russell 2000 up 11.0% in November, while international equities faced headwinds from a strengthening U.S. dollar.

December brought additional confirmation of the economy’s resilience, supported by a strong rebound in jobs data. Payrolls grew by 277,000 in November, though the unemployment rate ticked slightly higher. A modest rise in the Consumer Price Index (CPI) to 2.7% year-over-year confirms that the path to the Fed’s 2% inflation target will be bumpy, but it should not deter the central bank from cutting interest rates as expected in its December meeting. The NFIB Small Business Optimism Index rebounded strongly while the corresponding Uncertainty Index plunged from its record high, indicating emerging confidence among business owners’ outlooks.

Despite these positive indicators, mixed messages persist. While equities have surged, bond markets have sent a more cautious signal, with the 10-year Treasury yield rising to 4.30%, approximately 50 basis points (bps) higher than where it started the quarter. In addition to indigestion from sticky inflation, the rise in yields reflects concerns about potential fiscal challenges, including deficit expansion and the implications of higher tariffs or other protectionist policies under the new administration.

Federal Reserve Policy: Balancing Conflicting Signals

The Federal Reserve faces a challenging landscape as it approaches its final policy meeting of the year. Market participants are pricing in the near certainty of another 25 bps cut to the federal funds rate, which would mark 100 bps of cuts since September. The Fed’s decision-making is complicated by conflicting economic signals: a seemingly robust labor market and growing consumer sentiment on one hand, and slightly rising inflation and ongoing concerns about slowing global growth and financial market volatility on the other.

Diverging Sector Performance

Sector performance has been uneven throughout the quarter, reflecting both macroeconomic trends and shifting investor sentiment. In November, Consumer Discretionary stocks led the market with a 13.3% gain, driven by strong retail earnings and holiday spending forecasts, while Health Care eked out a mere 0.3% return. This divergence underscores the importance of careful sector allocation and stock selection in today’s market environment.

The technology sector, a dominant driver of market gains earlier in the year, saw mixed results as concerns over valuations and delayed returns on AI investments weighed on mega-cap names. However, cyclical sectors such as Industrials and Financials have shown renewed strength, benefiting from expectations of infrastructure spending and improving economic fundamentals.

Fixed Income: Rising Yields and Implications for Investors

The bond market’s narrative has evolved significantly over the quarter. While short-term rates have moved lower in line with Federal Reserve cuts, long-term rates have risen, driven by expectations of future inflation and fiscal pressures. The 10-year Treasury yield’s climb to 4.30% has implications across the economy, from housing affordability to federal debt servicing costs.

Higher mortgage rates have continued to weigh on the housing market, both by increasing borrowing costs and by discouraging current homeowners from selling properties with low-rate mortgages. This dynamic has constrained housing supply, adding to affordability challenges. Additionally, elevated Treasury yields highlight the potential risks to government finances, with higher interest costs exacerbating an already substantial federal deficit.

Geopolitical and Policy Uncertainty

Geopolitical factors and policy uncertainty remain significant variables for markets. Early in December, news of potential tariffs from the incoming administration raised concerns about trade relationships and their economic impact. While we believe broad-based tariffs are more likely a starting point for negotiations than a final policy objective, their implementation could create short-term volatility. And, while much of the tariff debate has been centered around inflation, we view them more as a tax rather than as a driver of sustained inflation. Countries targeted by tariffs often respond by devaluing their currencies relative to the U.S. dollar, mitigating the impact on import prices. As a result, the U.S. dollar has strengthened, creating additional headwinds for non-U.S. assets but reinforcing the relative appeal of domestic equities and fixed income. Investors will need to monitor developments closely as trade negotiations evolve in 2025.

Another area of focus is fiscal policy. The new administration’s spending proposals and tax reforms could have significant implications for both equities and fixed income. While lower corporate tax rates would provide a tailwind for corporate earnings, potential changes to individual tax rates, including capital gains taxes, could impact investor behavior. As we approach the expiration of the current tax code next year, the market may see increased volatility as investors adjust to the new policy environment.

Looking Ahead

As we enter 2025, investors should prepare for a more challenging environment. Historically, years following consecutive 20%-plus gains in the stock market have been more subdued. Current valuation metrics suggest that equities are priced for perfection, leaving little room for error. At the same time, the strength of the U.S. economy and consumer resilience provides a solid foundation for growth.

For equity investors, this will likely be a period where careful active management and disciplined stock selection are rewarded. We continue to focus on companies with reasonable valuations and durable competitive advantages, particularly those less exposed to policy shifts or geopolitical disruptions. In fixed income, higher yields have made bonds a more attractive component of balanced portfolios, offering both income and downside protection in the event of equity market volatility.

Asset allocation remains a critical tool for managing risk and capturing opportunities. As always, we counsel investors to maintain a long-term perspective, recognizing that periods of market turbulence are an inherent part of investing. With thoughtful planning and a focus on quality, we believe portfolios can weather the uncertainties ahead and continue to deliver on their objectives.

This piece was authored by Patrick Ryan, CFA®, Chief Investment Strategist, Head of Multi-Asset Solutions, and Portfolio Manager for Madison Investments. He also serves as a member of the Investment Risk Oversight Committee and is a Madison Investments Foundation board member.