US stocks cap best two years in a quarter-century

US stocks roared to another blockbuster showing, creating millionaires and turning professional investors increasingly bullish. But few expect such a torrid advance in the year to come.

The S&P 500 climbed 23 per cent, notching 57 record closes as the economy remained healthy.

US stocks roared to another blockbuster showing in 2024. Few expect such a torrid advance in the year to come.

The S&P 500 climbed 23 per cent, notching 57 record closes as the economy remained healthy, inflation ticked lower and an AI-fuelled rally in big tech stocks powered on. Even with a stumble in the last few trading days, the broad U.S. stock index wrapped up its best consecutive years since 1997 and 1998, according to Dow Jones Market Data, during the lead-up to the bursting of the dot-com bubble.

The rally has created millionaires and turned professional investors increasingly bullish: In December, the Bank of America Global Fund Manager Survey found record enthusiasm for US stocks, as measured by the net share of respondents favouring the group. The pay-offs haven’t been limited to the equity market: Gold had its best year since 2010, while bitcoin more than doubled, vaulting above $US100,000 for the first time before slipping below that mark.

Many investors anticipate that a resilient US economy and a Federal Reserve that has switched to cutting interest rates — even if not as deeply as some had hoped — will allow stocks to push higher. But they caution against thinking that the rapid pace of gains in the past two years will repeat in 2025.

For one thing, interest rates may remain higher than anticipated, affecting borrowing costs and potentially giving investors lower-risk alternatives to the stock market. The Fed recently signalled doubt over how much more it will cut rates. Benchmark Treasury yields had been rising even before that.

For another: The powerful rally has left stocks looking increasingly expensive. The S&P 500 traded late last week at 21.9 times its projected earnings over the next 12 months, according to FactSet, above a 10-year average of 18.5 times. Some investors argue that the hefty presence of fast-growing tech stocks in today’s market justifies a richer multiple than in the past. But many still worry the market looks pricey.

By itself, a lofty price tag is unlikely to stop the rally. But it will weigh on the returns that investors can expect over the long term and heighten the importance of corporate profit growth to stock performance.

“The market has sort of topped out in terms of multiple and can really only grow through earnings,” said Brad Conger, chief investment officer at Hirtle Callaghan & Co. “It puts a high burden on companies to actually deliver.” They could be up against a high bar: Wall Street analysts expect profits from companies in the S&P 500 to grow 15 per cent in 2025, up from a projected 9.5 per cent for 2024, according to FactSet. Traders look ready to punish companies that give reason to worry. Adobe shares recently dropped 14 per cent in a day after the software maker offered weak sales guidance.

Over the past year, investors began to turn a more sceptical eye to the question of when companies’ spending on artificial intelligence will turn into profits. Shares of Google parent Alphabet and Amazon.com stumbled when investors looked askance at a pairing of heavy spending with signs of disappointing sales growth.

Even so, the biggest tech stocks continued to do much of the work of powering the S&P 500 higher. Through December 24, the Magnificent Seven — Alphabet, Amazon, Apple, Meta Platforms, Microsoft, Nvidia and Tesla — accounted for more than 53 per cent of the stock index’s total return, including dividends, according to S&P Dow Jones Indices. Nvidia alone made up 21 per cent of the return, as the maker of artificial-intelligence chips saw its market value leap past $US3 trillion.

At the same time, stocks in many industries contributed to the rally. The financial sector climbed 28 per cent for the year, while the utilities and industrials segments gained 20 per cent and 16 per cent, respectively. In the year to come, many investors expect the market will continue to broaden.

“With the economy doing well, with the Fed cutting interest rates, with continued investment in infrastructure and the economy, we see scope for other sectors to play some catch-up with tech,” said Holly MacDonald, chief investment officer at Bessemer Trust.

Stocks outside of big tech also boast more attractive valuations, MacDonald noted. Bessemer Trust is favouring stocks in the industrial, utility, healthcare and technology sectors, but has reduced its tech position since the start of 2024, she said.

One beaten-down corner of the market that many investors are talking about: small-capitalisation stocks. The Russell 2000 benchmark is 8.7 per cent off its record close from November 2021, while the S&P 500 has risen 25 per cent over that time. The disparity has money managers thinking the market’s smaller stocks may be due for another look.

“They’ve underperformed by such a degree,” said Marc Pinto, head of Americas equities at Janus Henderson Investors. “We think that potentially sets us up for some mean reversion where small-caps will catch up.” Analysts expect small-caps to benefit as the Fed lowers interest rates. The group tends to issue more floating-rate debt than do larger companies, so its borrowing costs should fall if the central bank eases monetary policy.

Still, there are reasons for concern. The Fed jolted markets in December when it reduced rates but signalled just two additional cuts next year, suggesting borrowing costs may settle at a higher level than investors expected.

The Russell 2000 slumped 4.4 per cent on the news in its worst day in 2 1/2 years, while the Dow Jones Industrial Average dropped more than 1,100 points, its 10th consecutive day lower. The blue chip average’s losing streak was its longest since 1974.

Even as the Fed began cutting rates, the yield on the 10-year US Treasury note has ticked higher. The yield on the benchmark government bond settled Tuesday at 4.577 per cent, up from 3.860 per cent at the end of last year and 3.685 per cent on the day the central bank announced its first rate cut in September.

Uncertainty abounds on the political front. Stocks rallied when Republicans swept the November elections, raising hopes that business will benefit from tax cuts and looser regulation. But President-elect Donald Trump has also proposed sweeping tariffs as well as mass deportations, policies that could add to inflation if enacted.

“What happens to all this excitement when we start to get all the details?” said Anna Rathbun, chief investment officer at CBIZ Investment Advisory Services. “We don’t know what the tariffs are going to look like. We don’t know what deregulation is going to look like.” At the very least, many investors expect, markets could be in for a bumpy ride in 2025.

The Wall Street Journal