The Big Picture

Just about everything went the stock market's way in 2024, and even when it didn't, the stock market still found a way to spin the not-so-good into something good. To wit:

• Treasury yields went up, but for a good reason: growth was stronger than expected.
• Israel's war with Hamas expanded to involve Hezbollah, but that was okay because it was confined to proxy battles as opposed to being a wider regional conflict.
• Russia's war with Ukraine grew more intense, but the battlefronts remained Russia and Ukraine (mostly Ukraine).
• Inflation continued to stick above the Fed's 2.0% target (currently 2.4%), but it dropped from 2.7% at the end of 2023.
• The Fed did not cut rates as much as expected, but it didn't need to because growth held up.
• Market breadth was narrow for a good part of the year, but that was okay because the mega-caps outperformed and carried the indices.
• The stock market had a summer swoon on the unwinding of yen-based carry trades, relatively disappointing earnings results from Tesla (TSLA) and Alphabet (GOOG), and talk of increased restrictions on semiconductor exports to China, but that was a buy-the-dip opportunity in a market that didn't allow much time this year to wait on buying the dips.

Let's simply call 2024 a very good year. The journey didn't matter as much to index investors as the destination. For the second straight year, the market cap-weighted S&P 500 achieved a 20%+ price return. 

It was a different story for the equal-weighted S&P 500, which saw a more modest gain of 11.0% -- quite good for any given year, but sub-standard in 2024 when the Nasdaq Composite gained 28.6%, the Dow Jones Industrial Average increased 12.9%, and the S&P Midcap 400 Index rose 12.2%. Only the small-cap Russell 2000 had a "worse" year, rising "only" 10.0%.

There were plenty of gains to be had then, but the biggest gains were found in the biggest stocks, captured homogenously in the 32.3% gain for the Vanguard Mega-Cap Growth ETF (MGK).

AI Leadership

The mega-cap stocks assumed a leadership position that they only ceded sparingly at times. Ultimately, they were favored in a year that favored owning quality in terms of financial strength, quality in terms of industry leadership, and/or quality in terms of AI leadership.

No stock exuded the AI leadership quality better than NVIDIA (NVDA), which was at the center of every AI conversation because its GPUs are at the center of data center buildouts, large language models, and generative AI.

The AI growth enthusiasm was put to the test with every NVIDIA earnings report, and fortunately NVIDIA passed that test every time, creating its own halo effect that excited the trading masses and fostered an appreciation for the AI-related growth (and growth prospects) in other companies like Apple (AAPL), Oracle (ORCL), Broadcom (AVGO), Salesforce (CRM), Meta Platforms (META), Alphabet (GOOG), Amazon.com (AMZN), Microsoft (MSFT), and Tesla (TSLA) to name just a few.

A lot of growth enthusiasm got priced into those stocks, begging the question of whether the stocks have gotten ahead of themselves and now face impossibly high expectations going into 2025. The answer will be in the price action of the stocks in the wake of future earnings reports.

Recognizing a Good Thing

The price action in 2024, for the most part, was better than fine, and it was buttressed by several variables that bolstered the stock market's 2024 performance. Those variables included:

• A recognition that the economy avoided a recession
• A recognition that there was continuing disinflation that would encourage the Fed to cut rates
• A recognition that the Fed was teeing up the market to expect a removal of policy restraint (the first cut -- a 50-basis points cut -- came in September and was followed by 25-basis points cuts at the November and December FOMC meetings)
• A recognition that earnings growth was holding up and that forecasts for 2025 called for even stronger earnings growth
• A recognition that there would not be a contested presidential election and that President-elect Trump (and the GOP-led Congress) would be pushing for less regulation and lower tax rates

The latter triggered a post-election rally that saw the S&P 500, Nasdaq Composite, Dow Jones Industrial Average, Russell 2000, and S&P Midcap 400 all hit new record highs in the fourth quarter. It also spurred a spike in Bitcoin above $100,000 and unleashed a wave of speculative fervor driven by a fear of missing out on further gains.

The Nasdaq, led by none other than its mega-cap constituents, would end the year near its high, but the other indices faded away from their highs with small-cap and mid-cap stocks getting hit hard in December on stepped-up selling interest precipitated by rising interest rates.

The benchmark 10-yr note yield, at 3.64% the day before the Fed cut rates by 50 basis points on September 18, traded as high as 4.64% in late December. The bump in market rates after the Fed cut rates was attributed in large part to the market's concerns about inflation remaining elevated and the budget deficit remaining unacceptably high. To be fair, an economy performing better than expected also played a part.

The Fed, which helped drive the stock market's gains for much of the year, helped drive the December retreat with a forecast for fewer rate cuts in 2025 than previously expected. The tempered forecast had to do with the progress on inflation having slowed and the specter of it remaining elevated in 2025 due to President-elect Trump's tariff proposals and plans to implement mass deportations of illegal immigrants.

Meshing Nicely

Higher interest rates served as a headwind for a richly-valued stock market at the end of the year. At 21.9x forward twelve-month earnings, the market cap-weighted S&P 500 trades at a 20% premium to its 10-year average, according to FactSet.

That multiple, though, reflects a lot of good things that happened in 2024 and an expectation that more good things will follow in 2025. That's a nice thought, but the reality is that there isn't much, if any, room for error when it comes to earnings reporting.

That is a 2025 issue, however. 2024 unfolded with double-digit earnings growth (10%) spearheaded by the mega-cap companies.

The double-digit earnings growth was a by-product of impressive economic growth and was a foundational element for a very good year in the stock market. The economy itself was underpinned by a fairly solid labor market and rising real income that helped fuel consumer spending.

Real GDP growth averaged 2.6% for the first three quarters and accelerated in the second and third quarters. The Atlanta Fed GDPNow model estimate for real GDP growth in the fourth quarter is 3.1%.

The stock market isn't the economy, but the two meshed nicely this year in outperforming expectations that prevailed at the start of the year. 

That outperformance has raised the bar of expectations for 2025 with respect to earnings, the economy, politics, monetary policy, and the performance of the mega-cap stocks not to mention the broader market. To be sure, 2024 will be a tough act to follow in all respects, and especially so if long-term rates keep rising.

That is a development that bears close watching following a very good year for the stock market.

Happy New Year!

--Patrick J. O'Hare, Briefing.com