December 2024 Update on the Economy and Investment Markets

Key Economic Updates

⮚ U.S. Election Outcome: President-elect Trump led Republicans to a red sweep on election night. While the outcome was not necessarily a shock to investors, the dominance in most states by Trump, including winning the popular vote, did surprise many pundits. The results did not necessarily align with the polls and expectations leading up to the election that had forecasted a tight race. This was similar to what was observed with the 2016 Brexit Referendum outcome and Trump’s first Presidential victory. The question for investors will now become how far Trump will go in fulfilling his campaign promises for tax cuts, tariffs, deregulation and immigration reform among other issues and what this will mean for the U.S. economy and investment markets.

⮚ U.S. equities reached another new all-time high following election. The S&P 500 set a new all-time high the day after Trump was elected and went on to set a few more during a strong November performance. The index set its 53^rd new all-time high in 2024 on November 29^th, the fifth most on record for a single calendar year.

⮚ Fed Cut Rates by 0.25% in November as expected as they continued to pursue a “soft landing” for the U.S. economy. Investors will be focused on the Fed’s December meeting as expectations are that there will be another rate cut, but an inflation upside surprise when the November data is released or stronger than expected labor market reports could cause the Fed to pause.

⮚ Headline inflation rose to 2.6% in October from 2.4% the previous month. This was the first increase in seven months. October inflation data (reported in November) came in as expected with headline inflation (CPI) increasing 2.6% year-over-year (YoY) and core inflation (excluding volatile items such as food and energy) rising 3.3%. The Fed continues to target a 2% inflation rate.

⮚ U.S. GDP Growth slowed slightly in Q3 compared to Q2. U.S. GDP growth in Q3 came in at 2.8% YoY compared to 3% in Q2. The U.S. consumer continued its strong spending during the quarter.

⮚ The University of Michigan Survey of Consumer Sentiment Index for November came in at 71.8, the highest level in seven months. Surveys of Consumers Director Joanne Hsu stated: “Overall, the stability of national sentiment this month obscures discordant partisan patterns. In a mirror image of November 2020, the expectations index surged for Republicans and fell for Democrats this month, a reflection of the two groups’ incongruous views of how Trump’s policies will influence the economy.”

⮚ Geopolitics: The war in Ukraine escalated during November as Ukraine and Russia plan for a Trump presidency that will most likely change the direction of the war. In Israel, the conflict in Gaza and the humanitarian crisis it has created continued, but Israel did agree to a ceasefire with Hezbollah in Lebanon late in the month.

Election Outcome

As SFG has stated previously, history shows us that markets tend to like gridlock in D.C. That is not what investors are going to be dealing with over the next two years. The red sweep of the White House and Congress combined with conservative control of the Supreme Court put Republicans in a position to push through their agenda. Trump made aggressive campaign promises on tax cuts, tariffs, deregulation and immigration. The question for Americans and investors now becomes how far will and can he go in each of these areas. Trump kicked-off Thanksgiving week with a surprise announcement that he would be implementing a 10% tariff on top of existing tariffs on China and adding a 25% tariff to all goods imported from Canada and Mexico unless they deal with their open borders and stem the flow of drugs into the U.S. It is important to note that tariffs can be applied by executive order without going through Congress. While markets shrugged this off posting a new high the next day, there is concern about what a trade war would do to the economy, risk assets, and inflation. The proposed tariffs go way past what was implemented during his first term. One of our research providers, The Bank Credit Analyst (BCA), stated that, “The first trade war was clearly negative for global economic activity and risky asset prices. We have no reason to expect a different outcome this time around. In response to a massive rise in global trade uncertainty, the ISM manufacturing index declined significantly between 2018 and 2019, the Fed cut interest rates, long-maturity government bond yields fell, and US stocks approached bear market territory.”

This time around any tariffs will not be unexpected and the Fed is already cutting rates, so the question for investors will be whether the economy and markets take a different path this time. Equity markets are expensive, so any contraction in the global economy flowing through to corporate earnings or investor sentiment could cause a pullback in global equities. On the tax front, it is assumed that the Tax Cuts and Jobs Act passed during Trump’s first term will be extended. How far the administration goes beyond this in cutting either individual or corporate tax rates or removing taxes entirely on income from tips or overtime as has been put forward will affect the deficit. Tariffs can offset a portion of this reduction in government revenue, but significant additional cuts will be required to prevent the deficit from rising. This will be a tougher ask for Congress as entitlements are sensitive areas and interest expense and defense spending will be difficult to reduce in a material amount. Trump’s appointment for Treasury Secretary, Scott Bessent, comes from the hedge fund world and will attempt to balance keeping Wall Street and Trump happy. It will be a difficult tightrope to walk and could have a significant impact on the markets and investors.

Stocks

The S&P 500 closed November up 28% year-to-date (YTD). Strong corporate earnings, a relatively strong economy, an accommodating Fed and positive investor sentiment (leading to multiple expansion) have pushed stocks higher this year. Through November, the S&P 500 had set 53 new all-time highs in 2024 while the equal-weighted S&P 500 rose to more than 25 new all-time highs. This has pushed valuations higher and created a market that is expensive relative to recent history. This chart shows various valuation metrics comparing today’s levels to the average of the past 30 years.

Across these measures, the market looks expensive and is going to require strong corporate earnings growth and positive investor sentiment to maintain these levels and push to more all-time highs in 2025. SFG has previously discussed how starting point matters for both stock and bond returns over the long-term.

While short-term returns over the next year from a starting point at today’s valuations have shown a wide variance over the past 25 years, the 5-year returns have been well below historical equity return levels. This aligns with many capital market expectations that have been generated in recent months along with SFG’s own views of equity returns over the coming years. We expect U.S. equity returns will be extremely challenged to produce returns in line with those observed over the past decade.

Below is a chart showing one example of capital market expectations, BCA’s asset class forecasts for the coming decade. For the first time in a while, bond expectations look relatively attractive compared to stocks. Also, alternatives (ex. Private real estate, infrastructure, private equity, etc.) look relatively attractive compared to the other asset classes.

Fed, Inflation and Interest Rates

For the first time in a while, the Fed meeting in November seemed to fly under the radar as it occurred during the week of the election. The Fed cut rates 0.25% as expected. It is still expected that they will cut another 25bps in December, but this is not a guarantee. On the political front, questions have arisen as to whether Trump will allow Powell to finish his term which is scheduled to last until May 2026. Reports came out during the month that Trump would allow Powell to complete his term, and Powell was asked about the situation during his press conference. Powell stated that he would not resign if asked and could not be fired based on current law. He did say that the results of the election will not affect policy: “So let me say that in the near term the election will have no effects on our policy decisions. As you know, many, many things affect the economy and anyone who writes down forecasts in their job will tell you that the economy is quite difficult to forecast, looking out past the very near term.” 

The challenge for Powell and the Fed will be making decisions before it is fully understood what Trump’s administration intends to implement. A trade war, immigration reform, and lower taxes could each reignite inflation, while deregulation could be deflationary.  If a trade war destabilizes the global economy, the Fed may need to cut in an attempt to stave off a recession. 

In their statement announcing the rate cut last month, the Fed reported that “Recent indicators suggest that economic activity has continued to expand at a solid pace. Since earlier in the year, labor market conditions have generally eased, and the unemployment rate has moved up but remains low. Inflation has made progress toward the Committee’s 2 percent objective but remains somewhat elevated. The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. The Committee judges that the risks to achieving its employment and inflation goals are roughly in balance. The economic outlook is uncertain, and the Committee is attentive to the risks to both sides of its dual mandate… The Committee is strongly committed to supporting maximum employment and returning inflation to its 2 percent objective. In assessing the appropriate stance of monetary policy, the Committee will continue to monitor the implications of incoming information for the economic outlook. The Committee would be prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee’s goals. The Committee’s assessments will take into account a wide range of information, including readings on labor market conditions, inflation pressures and inflation expectations, and financial and international developments.” 

A question for investors now becomes how low will the Fed take rates. The expectation looking out to the fall of 2025 has moved up significantly in recent months as can be seen in this chart. This has coincided with a rise in longer-term interest rates as the yield on the 10-year treasury has risen from 3.6% in mid-September to 4.2% at the end of November. The yield on the 1-year T-Bill has experienced a similar shift, moving from 3.9% to 4.3% over the same period. A question for 2025 will be whether rates continue this rise in anticipation of a reignition of inflation concerns or rising concerns about the U.S. fiscal situation.

While October inflation reports were in line with expectations, headline inflation (CPI) did increase from the previous month, rising 2.6% YoY. This rise was driven in part by continued housing-related inflation costs. Inflation may not be able to moderate much from here if the Trump Administration enacts its policies on tariffs, taxes and immigration unless the economy falters. With that said, inflation at these levels should be manageable.

International Geopolitics

The future of the wars in Ukraine and the Middle East took a turn last month with Trump’s victory. President Zelenskyy immediately set-up a call with Trump to discuss Ukraine. Trump had Elon Musk join the call with Zelenskyy which shows the power that Musk is expected to wield during this administration. While Zelenskyy made positive comments about the call, Trump and his administration want to end the war, likely ceding parts of Ukraine to Russia. In the weeks following this call, fighting escalated after Russia added North Korean troops to the battlefield and Biden authorized Ukraine to use U.S. supplied long-range missiles to strike targets inside Russia. In response, Russia revised its nuclear doctrine to lower the threshold for utilizing nuclear weapons. It will be interesting to see if Trump can end the war early in his administration. This will be a difficult endeavor as it will most likely require Ukraine to cede territory to Russia, and Russia to permit Ukraine to have certain security assurances from the West.

In the Middle East, there was some progress between Israel and its enemies as Israel and Hezbollah agreed to a ceasefire to their fighting in Northern Israel and Lebanon. However, a ceasefire between Israel and Hamas in Gaza remains out of reach. Qatar removed itself as the mediator between Israel and Hamas last month because of a perceived lack of seriousness by either side in the ongoing negotiations. Trump is likely to continue support for Prime Minister Netanyahu’s strategy, but there is mounting pressure from the International community to address the humanitarian crisis in Gaza. 

Beyond these ongoing wars, investors will be following closely how the relationship between Trump and China’s President Xi Jinping evolves with the potential for a trade war and escalating tensions in the South China Sea and Taiwan. Also, will Trump force anything to change with NATO? These are just a few of the questions that will be answered in the coming months.

SFG’s Take: The Trump administration has created a lot of unknowns for investors. Despite Trump being clear about his intentions on tariffs, taxes, deregulation and immigration, it is difficult to predict how far the administration will go on any of these issues. With this uncertainty and a stock market that is richly priced and vulnerable to any significant shocks to the economy, SFG continues to focus on diversification. With bonds and certain alternatives better positioned now compared to recent years, we believe these asset classes can complement stocks over the coming years as stocks may experience increased volatility.

The Fed has a tough task at hand over the coming months as it attempts to execute a soft landing despite a change in U.S. economic strategy. A reignition of inflation is a top concern that Powell and the Fed will have to manage in determining how much further to cut rates. We believe the Fed will attempt to remain accommodative as long as possible, which will lead to cutting rates a few more times over the coming year but fewer than previously forecasted. Outside of a recession, it is likely that interest rates will stay higher for longer. 

As we have discussed many times over the years, it is imperative that an investor be invested in the correct risk tolerance for their own personal situation. If you have concerns or want to revisit your current strategy, please do not hesitate to reach out to your wealth advisor.