View from the Observation Deck

Much has changed since the last time we updated this post just over one year ago. While not in today’s table, perhaps the most notable change is the global easing of central bank policy rates, which began with the Swiss National Bank in March 2024. Since then, the central banks of all but two of the countries represented in today’s table lowered their policy rates. The only exceptions are Japan (policy rate increased by 0.60%) and Australia (unchanged). In the U.S., for example, the Federal Reserve (“Fed”) lowered the federal funds target rate three times, from 5.50% (upper bound) on 7/26/23, to 4.50% on 12/19/24.

The real yields (yield minus inflation) offered by 10-year government bonds increased across most of the globe.

As shown in the columns marked “12-Month Change (Basis Points)”, the yields on most of the longer term government bonds in today’s table increased over the past 12-months, providing ballast to real yields. In addition, many major economies saw disinflation over the period (discussed in more detail below). As of 2/3/25, eight of the ten countries represented in today’s table had a positive real yield on their 10-year note (up from five the last time we posted on this topic). The eight countries and their respective real yields are as follows: Italy (2.00%); U.K. (1.99%); Australia (1.88%); France (1.71%); U.S. (1.63%); China (1.52%); Canada (1.16%); and Germany (0.08%).

Headline inflation declined substantially since our last post but remains elevated in several of the world’s largest economies. 

While not presented in today’s table, the pace of inflation, which was the impetus for elevated policy rates, fell below the target rate in all but four countries (the U.S., the U.K., Japan, and Germany). In the U.S., inflation’s resilience sits at the forefront of the continued debate regarding the Fed’s path moving forward. In December 2024, inflation, as measured by the trailing 12-month rate of change in the consumer price index (CPI) stood at 2.9%, up 0.5 percentage points from its most recent low of 2.4% in September 2024. Notably, SuperCore inflation, a closely watched indicator touted by the Fed, increased at a faster rate in 2024 than it did in 2023, according to Brian Wesbury, Chief Economist at First Trust Portfolios, LP. 

The yield curve between the U.S. 10-Year Treasury Note (T-note) and the 2-Year T-note disinverted in 2024.

Historically, an inverted yield curve has been a fairly accurate indicator of an impending economic recession. Data from the Federal Reserve Bank of San Francisco shows that an inverted yield curve has been a precursor to each of the last 10 economic recessions in the U.S. since 1955. After 783 consecutive days, the yield curve between these two benchmarks disinverted on 9/4/24, marking the end of the longest inversion in history. Fortunately for U.S. investors, a recession has yet to materialize, but we may not be out of the woods yet, in our opinion.

Takeaway: Despite recent cooling, inflation remains stubbornly high in several of the major economies covered in today’s table. Case in point, headline inflation readings are above stated targets in the U.S., the U.K., Japan, and Germany. Despite declining central bank policy rates, most of the countries in today’s table saw 10-year yields climb year-over-year. That said, short term interest rates fell among all but one country (Japan). We expect central bank policy rates will remain elevated in countries where inflation has reaccelerated but recognize that these decisions are largely data dependent. Should these economies face substantial stagnation their central banks could lower short term rates once again. We will continue to monitor the situation and report back as new developments occur.

This chart is for illustrative purposes only and not indicative of any actual investment. The illustration excludes the effects of taxes and brokerage commissions and other expenses incurred when investing. Investors cannot invest directly in an index. The S&P 500 Index is an unmanaged index of 500 companies used to measure large-cap U.S. stock market performance, while the S&P sector and subsector indices are capitalization-weighted and comprised of S&P 500 constituents representing a specific sector or industry. 

To Download a PDF of this post, please click here.

View from the Observation Deck

With fourth quarter earnings season well underway, we wanted to provide an update regarding estimated 2024 and 2025 earnings and revenue growth rates for the companies that comprise the S&P 500 Index (“Index”). On January 28, 2025, the Index closed at 6,067.70, representing an increase of 27.21% on a price-only basis from when it closed at 4,769.83 on December 29, 2023, according to data from Bloomberg. For comparison, from 1928-2024 (97 years) the Index posted an average annual total return of 9.71%. We have maintained that increased revenues could boost earnings and provide the catalyst that drives equity returns higher going forward. We believe that the Index’s continued price improvement is reflective, in part, of that scenario playing out.

The most recent estimates reveal favorable earnings growth expectations in 2024 and 2025.

As today’s table shows, earnings for the companies that comprise the Index are estimated to increase by a combined 10.1% and 12.4%, respectively, year-over-year (y-o-y) in 2024 and 2025. In our last post on this topic, these figures stood at 9.7% and 12.8%, respectively (click here). Keep in mind that estimates for 2024 reflect favorable comparisons to 2023’s earnings which declined by 0.9% in 2023 (not in table). In 2024, earnings are estimated to decline in three of the eleven sectors that comprise the Index (Energy, Industrials, and Materials), unchanged from our last post. In 2025, however, earnings are estimated to increase for each of the Index’s sectors.

Revenue growth rate estimates remain favorable.

As of January 24, 2025, the estimated revenue growth rate for the companies in the Index stood at 5.3% and 5.6%, respectively, in 2024 and 2025. These figures increased since our last post when they stood at 5.2% and 5.5%, respectively. Ten of the eleven sectors that comprise the S&P 500 Index reflect positive y-o-y revenue growth rate estimates for 2024, with five of them estimated to surpass 5.0%. For comparison, seven of the eleven sectors are estimated to see revenue growth in excess of 5.0% in 2025.

Takeaway: As we’ve previously observed, equity markets are forward-looking discounting mechanisms, meaning the price of an efficient market should reflect the sum-effect of present and future (expected) events. With that in mind, we believe that the recent total returns in the S&P 500 Index, which increased by 26.26% & 25.00% in 2023 and 2024, respectively, are representative of the earnings and revenue growth rates shown in today’s table. Notably, earnings estimates reveal that analysts expect much broader market participation in 2025 than in 2024. Time will ultimately reveal the accuracy of these estimates, but we maintain that higher revenues could be the best catalyst for growing earnings, and in turn, drive equity prices higher.

This chart is for illustrative purposes only and not indicative of any actual investment. There can be no assurance that any of the projections cited will occur. The illustration excludes the effects of taxes and brokerage commissions or other expenses incurred when investing. Investors cannot invest directly in an index. The S&P 500 Index is an unmanaged index of 500 companies used to measure large-cap U.S. stock market performance. The respective S&P 500 Sector Indices are capitalization-weighted and comprised of S&P 500 constituents representing a specific sector.

To Download a PDF of this post, please click here.

View from the Observation Deck

In September 2018, the Telecommunications sector was renamed the Communication Services sector as part of a broad reconstitution of the S&P 500 Index. The number of constituents in this sector expanded from just a handful of telecom carriers to 22 companies today. The new members have brought more diversification to the sector via exposure to the internet, media, and entertainment industries (see subsectors in chart above). These companies were formerly members of the Information Technology and Consumer Discretionary sectors. Click here to view our last post on this topic.

As indicated in the chart above, the S&P 500 Communication Services Index (Communication Services Index) has significantly underperformed the S&P 500 Information Technology Index (Information Technology Index) since its inception.

That said, of the eleven sectors that comprise the S&P 500 Index, the Communication Services Index was the top performer in 2024, posting a total return of 40.23%. Information Technology came in second, with a total return of 36.61% over the period.

With a total return of 5.43% year-to-date through 1/27/25, the Communication Services Index is the fifth-best performing sector. The S&P 500 Health Care and Financials Indices were the first and second-best performers with total returns of 7.26% and 6.40%, respectively, over the same period.

After blockbuster growth in 2024, the earnings outlook for the Communication Services Index is mixed for 2025.

As of 1/24/25, data from Bloomberg showed that the earnings per share (EPS) for the Communication Services Index were estimated to increase by 26.79% in 2024. The figure represents the highest estimated earnings growth rate of all eleven sectors that comprise the broader S&P 500 Index. By contrast, the 2024 EPS growth estimate for the S&P 500 Index stood at 10.11% on 1/24/25. With a current estimate of 11.02%, however, the Communication Services Index’s EPS is not expected to increase at nearly the same rate in 2025.

Takeaway: The Communication Services Index posted the highest total return (+40.23%) of all eleven sectors that comprise the broader S&P 500 Index in 2024. In our view, unprecedented interest in Artificial Intelligence (AI) has been a major catalyst to surging valuations within the sector. Since its inception in 2018, the Information Technology Index (another of AI’s chief benefactors) is the only sector to outperform the Communication Services Index. In our view, investors would be well-served to monitor recent developments among competing AI companies closely. As the cost to integrate AI declines, we expect increased adoption among industries that have yet to benefit from the technology. Furthermore, we expect that interest rate policy will continue to influence investor behavior over the near-term. The Communication Services and Information Technology Indices are the fifth-best and worst performing sectors, respectively, since Jerome Powell revealed interest rate cuts were forthcoming on 7/9/24, posting total returns of 13.36% and -2.25%. The S&P 500 Financials and Consumer Discretionary Indices, by contrast, increased by 24.18% and 22.95% (total return) respectively, over the same period.

This chart is for illustrative purposes only and not indicative of any actual investment. The illustration excludes the effects of taxes and brokerage commissions and other expenses incurred when investing. Investors cannot invest directly in an index. The S&P 500 Index is an unmanaged index of 500 companies used to measure large-cap U.S. stock market performance, while the S&P sector and subsector indices are capitalization-weighted and comprised of S&P 500 constituents representing a specific sector or industry. 

To Download a PDF of this post, please click here.

View from the Observation Deck

Investors directing capital into U.S. mutual funds and exchange traded funds (ETFs) favored passive investing over active management in 2024.

Passive mutual funds and ETFs reported estimated net inflows totaling $885.94 billion in 2024, while active funds reported estimated net outflows totaling $165.36 billion during the year. The top three active categories with net inflows over the past 12 months were Taxable Bonds, Nontraditional Equity, and Municipal Bonds, with inflows of $223.93 billion, $43.28 billion, and $36.97 billion, respectively (see table above). For comparison, the top three passive categories were U.S. Equity, Taxable Bond, and International Equity, with inflows of $462.28 billion, $258.53 billion, and $96.04 billion, respectively.

Despite compelling total returns in the broader equity markets, equity mutual funds and ETFs saw much lower inflows than their fixed income counterparts over the trailing 12-month period.

Combined, the active and passive equity categories experienced inflows of $136.32 billion for the in 2024 (not in table). For comparison, the Taxable and Municipal Bond categories reported net inflows totaling $529.53 billion over the same time frame. The S&P 500, S&P MidCap 400, and S&P SmallCap 600 Indices posted total returns of 25.00%, 13.89%, and 8.64%, respectively, in 2024, according to data from Bloomberg. With respect to foreign equities, the MSCI Emerging Net Total Return and MSCI Daily Total Return Net World (ex U.S.) Indices posted total returns of 7.50% and 4.70%, respectively, over the same time frame. For comparison, the Bloomberg Municipal Long Bond, Bloomberg U.S. Aggregate, and Bloomberg Global-Aggregate Bond Indices saw total returns of just 1.40%, 1.25%, and -1.69%, respectively, during the year.

Takeaway: Passive mutual funds and ETFs saw inflows of $885.94 billion compared to outflows of $165.36 billion for active funds over the trailing 12-month period ended 12/31/24. U.S. Equities experienced the largest disparity, with active shedding $295.71 billion compared to inflows of $462.28 billion for passive funds. Yet again, despite compelling total returns in the broader equity markets, equity funds saw smaller net inflows than their fixed income counterparts. Net inflows into active and passive equity ETFs totaled 136.32 billion during the year, whereas fixed income saw combined net inflows of $529.53 billion over the same time frame. Overall, U.S. long term ETFs saw net inflows of $720.58 billion in 2024, an increase of nearly 2.7% year-over-year. The figure represents the third-highest total over the past 10 years. Of the ten category groups in the table, only sector equity and allocation funds saw net outflows during the year.

This chart is for illustrative purposes only and not indicative of any actual investment. The illustration excludes the effects of taxes and brokerage commissions and other expenses incurred when investing. Investors cannot invest directly in an index. The S&P 500 Index is an unmanaged index of 500 companies used to measure large-cap U.S. stock market performance. The S&P MidCap 400 Index is a capitalization-weighted index that tracks the mid-range sector of the U.S. stock market. The S&P SmallCap 600 Index is a capitalization-weighted index that tracks U.S. companies with a small market capitalization. The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets. The MSCI World (ex U.S.) Index is a free-float weighted index designed to measure the equity market performance of developed markets. The Bloomberg Municipal Long Bond Index cover the USD-denominated long-term tax exempt bond market, including local general obligation, revenue, insured, and prefunded bonds. The Bloomberg U.S. Aggregate Bond Index measures the investment grade, U.S. dollar-denominated, fixed rate taxable bond market. The Bloomberg Global Aggregate Bond Index measures global investment grade debt in local currency markets. 

To Download a PDF of this post, please click here.

View from the Observation Deck

Like many of you, we have been closely watching the economic impact of changing policy rates (real or implied) in the U.S. over the past several years. We even wrote several pieces highlighting the effect of these changes on the broader equity markets (click here for a recent example). For today’s post, we will investigate the influence of these policy changes on a smaller subset of the equity market, namely the banking and financial sectors. To do so, we plotted the price-only returns of the S&P Banks GICS Level 2 Index, S&P Regional Banks Index, and S&P 500 Financials Index against the broader S&P 500 Index. Our observations begin on 7/9/24, the day after Federal Reserve Chairman Jerome Powell’s testimony to Congress that the U.S. economy no longer appeared to be “overheated”.

Powell’s initial comments sent interest rate expectations sharply lower. By the end of the year, however, implied interest rates surged amidst stronger than expected economic data.

On 7/8/24 (the day of Powell’s address), the federal funds rate futures market implied that the federal funds target rate would decline to 4.67% by 1/29/25. For comparison, the federal funds target rate (upper bound) stood at 5.50% that same day. The market adjusted quickly in the wake of Powell’s comments. On 9/30/24, the same market predicted the federal funds target rate would decline to 3.82% by 1/29/25. These expectations waned in the months since, challenged by better-than-expected economic data, stubbornly high inflation, and persistent consumer spending. As of 1/16/25, the futures market implied that the federal funds target rate would decline to 4.32% on 1/29/25. For comparison, the federal funds target rate (upper bound) was 4.50% on 1/16/25.

On 9/4/24, after 783 consecutive days, the longest yield curve inversion in U.S. history ended.

At market close on 9/4/24, the yield on the benchmark 10-Year U.S. Treasury Note (T-note) closed at 3.76%. Notably, the yield on the 2-Year T-note also stood at 3.76% that day, marking the end of the longest yield curve inversion in U.S. history. As many investors are likely aware, a “normal” yield curve is one where investors demand a premium to lend assets over longer time frames. When the yield curve is inverted, shorter dated maturities command a higher premium than longer dated ones. This situation is particularly trying for companies in the financial and banking sectors, who earn profit by borrowing money from the Federal Reserve at short term rates and lending it to customers over longer terms. Understandably, as the yield curve normalized, banks’ expected profitability increased.

Earnings estimates for the S&P 500 Financials Index underwent substantial upward adjustments in the wake of Powell’s Congressional testimony.

On 1/17/25, analysts estimated that the S&P 500 Financials Index would see calendar year earnings growth of 14.30% in 2024, up substantially from when earnings were estimated to grow by just 6.86% on 7/5/24. Notably, the lion’s share of this increase can be attributed to surging earnings estimates for banks and financial services companies. On 1/17/25, analysts estimated an earnings growth rate of 3.18% for banks and 20.37% for financial services companies in 2024, up from -5.22% for banks and 12.39% for financial services on 7/5/24.

The total returns for the four indices in today’s chart from 7/9/24 – 1/16/25 were as follows:

S&P Regional Banks Index: 29.26%
S&P 500 Banks GICS L2 Index: 22.46%
S&P 500 Financials Index: 20.27%
S&P 500 Index: 7.18%

Takeaway: From our perspective, the yield curve’s normalization in the wake of Powell’s testimony was a significant catalyst to the banking and financial services companies that comprise the S&P 500 Financials Index. Case-in-point, valuations surged amid a rapid recalculation of earnings estimates for these companies (see above). Notably, the S&P 500 Financials Index has been the top performing subsector in the broader S&P 500 Index, posting a total return of 20.27% between 7/9/24 (the day after Powell’s testimony to Congress) and 1/16/25. For comparison, the Communication Services and Information Technology Sectors, which were the top performers in 2024, posted total returns of 8.68% and -0.03%, respectively, over the same period. That said, risks in the form of economic deterioration and the potential for restrictive lending standards remain. We will report back as developments warrant it.

The S&P 500 Index is an unmanaged index of 500 companies used to measure large-cap U.S. stock market performance. The S&P 500 Financials Index is a capitalization-weighted index of companies in the S&P 500 Index that are classified as members of the GICS financials sector. The S&P 500 Banks Index is a capitalization-weighted index. The S&P Banks Select Industry Index comprises stocks in the S&P Total Market Index that are classified in the GICS Asset Management & Custody Banks, Diversified Banks, Regional Banks, Diversified Financial Services and Commercial & Residential Mortgage Finance sub-industries. The S&P Regional Banks Select Industry Index is comprised of stocks in the S&P Total Market Index that are classified in the GICS regional banks sub-industry.

To Download a PDF of this post, please click here.

View from the Observation Deck

Today's blog post features the cumulative total returns of five major equity indices (three domestic and two foreign) since the start of 2000. We chose to highlight 5-year rolling total returns in an effort to smooth out intra-year volatility introduced by the significant number of challenging global events that transpired since 2000. We update this post on an annual basis. Click here to see the January 2024 version of this post.

Emerging markets equities clearly outperformed in the first decade covered in the table but have lagged the U.S. indices since. In the U.S., large-, mid-, and small-capitalization (cap) stocks have shared the spotlight dating back to 2007, with large-caps (S&P 500 Index) dominating each of the last seven 5-year rolling periods. From our perspective, continued globalization and a dramatically stronger U.S. dollar have been key catalysts to this shift in performance. While it is no secret that U.S. companies generate a significant portion of their revenue from overseas, many investors may not be aware of just how dependent they have become on international sales. Notably, 41.8% of S&P 500 Index revenues were generated outside of the U.S. as of 12/31/24.

Regarding the U.S. dollar: a strong dollar can decrease returns for U.S. investors holding positions in unhedged foreign securities, and vice versa. From 2000-2009, the U.S. Dollar Index declined by 23.57% − a nice tailwind for foreign holdings. From 2010-2019, the same index appreciated by 23.80% − a notable headwind for foreign holdings. During the current decade, spanning 2020-2024, the U.S. Dollar Index surged by 12.55% to 108.49, well above its 20-year average of 89.75.

For additional context, the average annual total returns for each of the five equity indices in today’s table were as follows (12/31/99 – 12/31/24): 9.66% (S&P MidCap 400); 9.50% (S&P SmallCap 600); 7.69% (S&P 500); 5.67% (MSCI Daily TR Net Emerging Markets in USD); and 3.78% (MSCI World ex-U.S.), according to data from Bloomberg.

Takeaway: The returns depicted in today’s table offer a powerful reminder that the buy and hold strategy can still serve investors well. Despite rising geopolitical tensions, wars, government lockdowns, and two bear markets (in the S&P 500 Index), each of the indices in today’s table reflect positive total returns over the most recent 5-year rolling period. While the S&P 500 Index remains a clear outlier, there is no way to predict what indices could outperform next. For those investors with extended time horizons, today’s table may serve as an antidote to an overly myopic outlook regarding their equity holdings.

This chart is for illustrative purposes only and not indicative of any actual investment. The illustration excludes the effects of taxes and brokerage commissions and other expenses incurred when investing. Investors cannot invest directly in an index. The S&P 500 Index is a capitalization-weighted index comprised of 500 stocks used to measure large-cap U.S. stock market performance. The S&P MidCap 400 Index is a capitalization-weighted index that tracks the mid-range sector of the U.S. stock market. The S&P Small Cap 600 Index is a capitalization-weighted index that tracks U.S. stocks with a small market capitalization. The MSCI World (ex-U.S.) Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed markets excluding the U.S. The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets. The U.S. Dollar Index (DXY) indicates the general international value of the dollar relative to a basket of major world currencies.

To Download a PDF of this post, please click here.

View from the Observation Deck
Dividend payments have been a key characteristic of most of the companies that comprise the S&P 500 Index (“Index”) for decades. In fact, as of 12/31/24, 407 of the 503 companies that comprise the Index paid a dividend. That figure is little changed from 1998, when 418 companies in the Index paid dividend distributions to shareholders. For today’s discussion, we set out to explain the fundamental relationship between dividends and earnings, and to determine if the recent record-high earnings in the Index have translated into higher yields.

The companies that comprise the Index distributed a record $630 billion in dividends in 2024 (preliminary data), up from $565 billion and $588 billion in 2022 and 2023, respectively. Despite record distributions, the dividend yield of the S&P 500 Index has been trending downward (see chart). 

As of 12/31/24, the yield on the Index stood at just 1.27%, down from 1.49% and 1.76% at the end of 2023 and 2022, respectively. For comparison, the yield on the Index averaged 1.90% over the full period captured in today’s chart.

The Index’s earnings are estimated to surge from $243.12 in 2024 to $273.23 in 2025 (as of 1/10/25).

Given that dividends are paid from profits, a company’s ability to increase its earnings plays a crucial role in assessing its capacity to maintain (or grow) its dividend payout. From our perspective, the consistent, long-term pattern of earnings growth revealed in today’s chart, combined with the continued decline in the Index’s yield, indicates that the environment is ripe for continued dividend growth.

The S&P 500 Index’s dividend payout ratio is currently well-below average.

As many investors are likely aware, the dividend payout ratio measures the percentage of earnings that are paid to shareholders in the form of dividends. The Index’s dividend payout ratio stood at just 37.28% on 12/31/24. For context, the Index’s dividend payout ratio averaged 41.80% (monthly basis) over the period captured in today’s chart.

Takeaway: Dividends have played an indispensable role in equity valuations for many decades. As noted above, the combination of low current yields, record-high earnings, and a below-average dividend payout ratio may be an indication that conditions are conducive to near-term dividend growth for the Index. In our last post on this topic (click here) we noted that companies will often hoard cash as recessionary pressures mount. Given strong recent economic data, we find that scenario to be less likely now than it was then. That said, dividends are just one of the ways companies return profit to shareholders. Another is stock buybacks. The most recent data from S&P Dow Jones Indices reveals that S&P 500 companies announced a total of $699.3 billion in share repurchases over the first three quarters of 2024, up from $576.1 billion over the same period in 2023.

This chart is for illustrative purposes only and not indicative of any actual investment. The illustration excludes the effects of taxes and brokerage commissions and other expenses incurred when investing. Investors cannot invest directly in an index. The S&P 500 Index is an unmanaged index of 500 companies used to measure large-cap U.S. stock market performance.

To Download a PDF of this post, please click here.

View from the Observation Deck

We are often asked what our favorite sectors are. Sometimes the answer is more evident than at other times, and often it only makes sense via hindsight. Today’s blog post is one that we update each quarter to lend context to our responses. While the above chart does not contain yearly data, only two sectors in the S&P 500 Index (“Index”) have been the top-performer in back-to-back calendar years since 2005. Information Technology was the first, posting the highest total return in 2019 (+50.29%) and 2020 (43.89%). Energy was the second, posting the highest total return in 2021 (54.39%) and 2022 (65.43%), according to data from Bloomberg.

• The top-performing sectors and their total returns in Q4’24 were as follows: Consumer Discretionary (14.25%), Communication Services (8.87%), and Financials (7.06%). The total return for the Index was 2.39% over the period. The other eight sectors generated total returns ranging from 4.84% (Information Technology) to -12.42% (Materials).
  
  
• By comparison, the total returns of the top performing sectors in the fourth quarter of last year were as follows: Real Estate (18.83%), Information Technology (17.17%), and Financials (13.98%). The worst-performing sectors for the period were: Health Care (6.41%), Consumer Staples (5.54%), and Energy (-6.99%).
  
  
• Notably, none of the three top sectors from Q3’24 were among the leaders in the most recent quarter. 
  
  
• Driven by continued advancements in artificial intelligence (AI), the S&P 500 Communication Services and Information Technology Indices saw total returns of 40.23% and 36.61%, respectively, during the 2024 calendar year.
  
  
• The S&P 500 Index posted a total return of 25.00% in 2024. Ten of the eleven major sectors that comprise the Index were positive on a total return basis.
  
  
• Click here to access our post featuring the top-performing sectors in Q1’23, Q2'23, Q3'23 and Q4’23.

Takeaway: As we observe from today’s chart, the top-performing sector often varies from quarter to quarter. The fourth quarter of 2024 was no exception, with the Consumer Discretionary, Communication Services, and Financials Indices rising to the top. From our perspective, the Consumer Discretionary Sector’s 14.25% total return is largely the result of persistent consumer spending. In total, consumers are estimated to have spent between $979.5 and $989.0 billion in November and December, representing an increase of 2.5% to 3.5% year-over-year. For the second year in a row the S&P 500 Index enjoyed a positive total return, increasing by 25.00% in 2024. Of the eleven sectors that make up the Index, the Communication Services and Information Technology Indices boast the highest total returns on a trailing 12-month basis (40.23% and 36.61%, respectively). That said, it is worth noting the dramatic turnaround in Utilities stocks in 2024. After weathering a total return of -7.08% in 2023 (the worst performer for the year), Utilities surged by 23.43% (total return) in 2024 making them the fifth-best performer during the year. Will a different sector rise to the top in the first quarter of 2025? We look forward to seeing what the data reveals.

This chart is for illustrative purposes only and not indicative of any actual investment. The illustration excludes the effects of taxes and brokerage commissions or other expenses incurred when investing. Investors cannot invest directly in an index. The S&P 500 Index is an unmanaged index of 500 stocks used to measure large-cap U.S. stock market performance. The respective S&P 500 Sector Indices are capitalization-weighted and comprised of S&P 500 constituents representing a specific sector.  

To Download a PDF of this post, please click here.

View from the Observation Deck

In a previous post (click here), we noted that Jerome Powell’s commentary to the Financial Services Committee on 7/9/24 appeared to have set the stage for a dramatic shift in the performance of small cap stocks relative to their large cap counterparts. For today’s post, we set out to expand our observations to include the price-only returns of the Bloomberg Magnificent 7, S&P 500 Equal Weighted, and S&P MidCap 400 Indices. The chart above includes the price-only returns of the specified indices from 7/9/24 to 12/10/24, normalized to a factor of 100. To avoid overcrowding the chart, the S&P 100 Index was removed from our dataset.

On 7/8/24, prior to Powell’s address, the federal funds rate futures market indicated there was a 72.0% chance that the Federal Reserve (“Fed”) would cut its policy rate at its September meeting. That expectation surged following his remarks, rising to 98.0% on 7/23/24.

As we now know, the Fed would cut its policy rate at both its September and November meetings. Currently, the federal funds target rate (upper bound) sits at 4.75%, down from 5.50% in July. 

Investors increasingly expect another rate cut in December.

On 12/11/24 the federal funds rate futures market indicated that there was a 99% chance the Fed would reduce its policy rate at its next meeting, up from a 66% chance less than two weeks ago on 11/29/24.

Valuations for the S&P 500 Equal Weight, S&P SmallCap 600, and S&P MidCap 400 Indices remain more attractive than those of the Blomberg Magnificent 7 and broader S&P 500 Indices.

As of 12/11/24, the price-to-earnings ratios for each of the indices in today’s chart were as follows: Bloomberg Magnificent 7 Index (42.43); S&P 500 Index (25.52); S&P 500 Equal Weighted Index (19.32); S&P MidCap 400 Index (18.54); and S&P SmallCap 600 Index (18.52).

For reference, the total returns for the five indices in today’s chart were as follows (7/9/24 – 12/10/24):

S&P SmallCap 600 Index: 18.00%
S&P MidCap 400 Index: 14.66%
Bloomberg Magnificent 7 Index: 13.40%
S&P 500 Equal Weighted Index: 12.50%
S&P 500 Index: 8.82%

Takeaway: As today’s chart clearly shows, market breadth has widened considerably since Powell’s speech in July. In our view, the catalysts behind this phenomenon, including lower interest rates, increasingly attractive valuations among smaller market capitalizations, and strong 2025 earnings estimates, will likely lead to further diversification into smaller companies. Earnings for the S&P Small Cap 600 Index are estimated to increase by 17.49% year-over-year (y-o-y) in 2025, the most of any index in today’s chart. For comparison, the 2025 earnings growth estimates for the remaining indices were as follows: Bloomberg Magnificent 7 Index (16.51%); S&P MidCap 400 Index (13.11%); S&P 500 Equal Weighted Index (12.71%); and S&P 500 Index (12.59%). Notably, earnings growth is expected to increase for all but one of the indices presented today. At 16.51%, the Mag 7 Index’s 2025 earnings growth estimate falls far short of 2024’s estimated earnings growth rate of 68.37% (as of 12/11/24). As always, these are estimates and are subject to constant revision. As investors begin to plan for 2025, we trust they will be asking: “what investments are worth the weight they’ve been assigned in my portfolio?” and adjusting accordingly.

This chart is for illustrative purposes only and not indicative of any actual investment. The illustration excludes the effects of taxes and brokerage commissions and other expenses incurred when investing. Investors cannot invest directly in an index. The S&P 500 Index is an unmanaged index of 500 companies used to measure large-cap U.S. stock market performance. The S&P 500 Equal Weighted Index is the equal-weight version of the S&P 500 Index. The Bloomberg Magnificent 7 Price Return Index is an equal-dollar weighted equity benchmark consisting of a fixed basket of 7 widely-traded companies in the U.S. The S&P MidCap 400 Index is a capitalization-weighted index which measures the performance of the mid-range sector of the U.S. stock market. The S&P SmallCap 600 Index is an unmanaged index of 600 companies used to measure small-cap U.S. stock market performance.

To Download a PDF of this post, please click here.

The blog will resume on Tuesday, January 7th.

View from the Observation Deck

The yield on the 10-year Treasury note (T-note) sat at an all-time low of 0.51% on 8/4/20, according to data from Bloomberg. The 10-year T-note’s yield increased substantially since then, climbing to 4.99% on 10/19/23 (most-recent high) before settling at 3.62% on 9/16/24 (most-recent low). As of 12/6/24, the yield on the 10-year T-note yield stood at 4.15%, representing an increase of 365 basis points (bps) from its all-time low. To view the last post we did on this topic, click here.

Seven of the 11 debt categories presented in today’s chart posted positive total returns over the period.

As many investors may be aware, bond yields typically move in the opposite direction of prices. In our previous post on this topic, we noted that the surge in the 10-year T-note’s yield coincided with a dramatic sell-off in the longer-duration fixed income categories we tracked. Today’s chart reveals that many of those fixed income asset classes have seen significant price recoveries since then. Notably, seven of the 11 debt categories represented in the chart exhibit positive total returns, up from just two in our last post.

Inflation, as measured by the trailing 12-month rate of change in the Consumer Price Index (CPI), stood at 2.6% at the end of October 2024, down from 3.2% in October of last year and 6.5 percentage points below its most recent high of 9.1% in June 2022.

Recent disinflation, coupled with a weakening U.S. labor market and softening global growth prompted the Federal Reserve (“Fed”) to reduce the federal funds target rate (upper bound) by a total of 75 bps over their last two meetings. That said, inflation remains above the Fed’s target of 2.0%, and there are concerns that it may not be entirely under control. In the U.S., consumer sentiment surged to a reading of 74.0 in December 2024 (preliminary results), up from its most recent low of 50.0 in June 2022. Holiday sales data paints a picture of a consumer willing to spend (and give!) in increasingly larger sums. Adobe Analytics reported that consumers spent a record $10.8 billion and $13.3 billion shopping online during Black Friday and Cyber Monday this year. Meanwhile charitable donations on Giving Tuesday (the Tuesday following Thanksgiving) surged by 16% year-over-year to a record $3.6 billion in 2024.

 
The total returns for intermediate-term U.S. and global government bonds remain sharply negative over the period captured in the chart.

The strength in the U.S. dollar likely had a negative impact on the performance of foreign bonds, in our opinion. The U.S. Dollar Index (DXY) increased by 13.57% over the period indicated in today’s chart, according to data from Bloomberg. The U.S. Dollar Index stood at 106.06 as of the close of trading on 12/6/24. Remarkably, the U.S. Dollar Index has closed above the 100 mark in all but four trading sessions since 4/13/22.

Takeaway: From our perspective, the fixed income environment has improved dramatically since our last post on this topic just over 13 months ago. Propelled by the combination of disinflation and easing monetary policy, 7 of the eleven indices we track posted positive total returns since 8/4/20, up from just two in our last post. Many investors making an allocation to fixed income do so for the yield these securities provide. Notably, given recent disinflation, the 10-year T-note has offered investors a positive real yield (yield minus inflation) for 17 consecutive months (thru 10/31/24). That said, it is possible that inflation, which remains above the Fed’s 2.0% goal, could march steadily higher. Persistent consumer spending and a stronger than expected U.S economy form the basis of this thesis. As of 12/6/24, the federal funds rate futures market revealed that investors expect just two interest rate cuts totaling 67 bps through the first six months of next year, down from four cuts totaling 100 bps at the end of October. We will update this post as new information becomes available.

This chart is for illustrative purposes only and not indicative of any actual investment. The illustration excludes the effects of taxes and brokerage commissions or other expenses incurred when investing. Investors cannot invest directly in an index. The ICE BofA U.S. High Yield Constrained Index tracks the performance of U.S. dollar denominated below investment grade corporate debt publicly issued in the U.S. domestic market. The Morningstar LSTA U.S. Leveraged Loan Index is a market value-weighted index designed to measure the performance of the U.S. leveraged loan market. The ICE BofA Emerging Markets Corporate Plus Index tracks the performance of U.S. dollar and euro denominated emerging markets non-sovereign debt publicly issued in the major domestic and eurobond markets. The ICE BofA Fixed Rate Preferred Securities Index tracks the performance of investment grade fixed rate U.S. dollar denominated preferred securities issued in the U.S. domestic market. The ICE BofA U.S. Mortgage Backed Securities Index tracks the performance of U.S. dollar denominated fixed rate and hybrid residential mortgage pass-through securities publicly issued by U.S. agencies in the U.S. domestic market. The ICE BofA 1-3 Year U.S. Corporate Index is a subset of the ICE BofA U.S. Corporate Index including all securities with a remaining term to maturity of less than 3 years. The ICE BofA 1-3 Year U.S. Treasury Index tracks the performance of U.S. dollar denominated sovereign debt publicly issued by the U.S. government with a remaining term to maturity of less than 3 years. The ICE BofA 22+ Year U.S. Municipal Securities Index tracks the performance of U.S. dollar denominated investment grade tax-exempt debt publicly issued by U.S. states and territories, and their political subdivisions with a remaining term to maturity greater than or equal to 22 years. The ICE BofA U.S. Corporate Index tracks the performance of U.S. dollar denominated investment grade corporate debt publicly issued in the U.S. domestic market. The ICE BofA 7-10 Year Global Government (ex U.S.) Index tracks the performance of publicly issued investment grade sovereign debt denominated in the issuer's own domestic currency with a remaining term to maturity between 7 to 10 years, excluding those denominated in U.S. dollars. The ICE BofA 7-10 Year U.S. Treasury Index tracks the performance of U.S. dollar denominated sovereign debt publicly issued by the U.S. government with a remaining term to maturity between 7 to 10 years. 

To Download a PDF of this post, please click here.