Welcome to our first Weekly Market Commentary for 2025. We’ll kick off the year by looking back at a few of our favorite charts for 2024. Then, with the 119th Congress newly sworn in on Friday, January 3, we also take a look at some policy mistakes that could derail our largely bullish policy outlook.
Favorite Charts From 2024
Last Tuesday, December 31, was the final trading day of the year. The S&P 500 stumbled a bit into the end of the year — the last all-time high close for the year was on December 6. But it was a good year for the widely followed index. The S&P 500 finished the year with a total return of 25.0%, the second consecutive year over 20%, which hasn’t happened since 1998 and 1999. (Lest that last year worry people, 1999 was the fifth consecutive year of a total return over 20%.) There’s an old saying that markets climb a wall of worry, and that neatly captures the last two years.
The Carson Investment Research Team put their heads together and chose some of the charts we thought best tell the story of 2024. Here are some of our favorites.
Chart 1: The President’s Party Is Not a Market Predictor
2024 was a presidential election year and we covered the election extensively from a market perspective. But when we did, we frequently reinforced that investing based on one’s political beliefs tends to be a fundamental mistake when it comes to markets. Policy matters, but markets don’t necessarily respond to policy at the time and in the manner expected and the macroeconomic environment matters more. (For example, during President Trump’s first term, energy stocks did poorly, despite an easier regulatory environment.) The bottom line is that if you weren’t in the market because you didn’t like the politics of President Obama, or President Trump, or President Biden, you missed out on some pretty good gains. Our first chart is the S&P 500 under various presidents. The most meaningful pattern is not what happens when it’s red or blue, but it’s overall historical rise due to the ability of companies to grow earnings.
Charts #2 and #3: Broad-based Gains Supported by Fundamentals
A lot has been written on how the S&P 500 is dominated by a small number of very large technology-oriented companies, sometimes called the Magnificent Seven. The index has indeed grown increasingly concentrated, but returns were much more broad based than just seven names. As the chart below shows, those names did contribute a little over half the gains of the S&P 500 in 2024, although that’s partially a function of their weighting in the index. (Note that performance here is strictly for the sake of understanding the market and should not be considered a recommendation.) In fact, the Equal Weight S&P 500 Index, where the Magnificent 7 only receive 1.4% of the weight, still had a total return of 13.0% in 2024. That does lag the cap-weighted index by more than 10%-points, but it also brings home that the environment for stocks in general was really pretty good in 2024.
Another theme we hear is that stock gains have been driven by valuations (multiples growth) where investors are simply willing to pay more for a dollar of profits. But as seen in the chart below, earnings growth has been a major contributor to stock gains this year. Of the 25% total return for the S&P 500 in 2024, 13%-points can be attributed to earnings growth and 2%-points can be attributed dividends, leaving 10%-points to multiple expansion. Yes, the index’s P/E has been rising and that does have the potential to pull from gains in the future, but it’s important to keep in mind that a lot of stock market performance continues to be driven by “fundamentals” (earnings growth and dividends). In fact, looking back over the last five years, the S&P 500 has had a total return of 97%. Of that, 76%-points can be attributed to fundamentals, leaving 21%-points for multiples expansion.
Chart 4: The Dollar
King Dollar reigned once again in 2024, with dollar skeptics again intoning the mantra they’ve clung to for decades, “We’re not wrong, we’re just early.” The US dollar index gained over 7% in 2024, a significant jump for the world’s reserve currency. The dollar index is now at its highest level in over two years and its climb captures most of the dynamics we saw in 2024, including:
- Strong US economic growth, on the back of above-trend productivity growth
- Outperformance of the US economy relative to other developed and emerging markets, as the rest of the world struggled
- A summer scare for the labor market, which increased expectations for the Fed to go for a big cut in September (which they did) and dollar weakness
- Rising interest rates in the US after September which led to dollar strength, amid strong economic data and the Fed taking recession risk off the table by committing to protect the labor market
- A relatively bigger monetary policy easing cycle in other developed economies, as central banks look to boost growth, even as the Fed may be in pause mode during the first half of 2025
- Post-election dollar strength is also a reminder that tariffs will be a focus in 2025
- Yet another year of US equity outperformance relative to international stocks, with the dollar acting as a major headwind. Japan was a prime example: the MSCI Japan index gained over 21% in local currency terms (easily besting the Dow’s 13% return, and not too far below the S&P 500’s 25% gain). However, the net USD-based return was only 8.3% thanks to the yen depreciating over 12%.
Chart 5: The Yield Curve
The Treasury yield curve (the relationship between short-term and long-term interest rates) also tells a lot of the story of 2024. As you can see below, over the course of the year, we went from a largely inverted yield curve at the end of 2023 (short-term rates higher than long-term rates) to a normally sloped curve at the end of 2024 (higher long-term rates). This happened because short-term rates have fallen well below where they were at the end of 2023 and long-term rates have risen. The pivot point is the two-year yield, which hardly moved.
That change tells a lot of the economic story for the year. Short-term yields fell on Fed rate cuts, although fewer than expected at the start of the year as the economy topped expectations. Long-term yields rose from a combination of improved growth expectations and increased uncertainty around inflation.
On a forward-looking basis, the change in the curve tells us that 10-year Treasuries are starting with a 1.78%-point head start versus 3-month Treasuries to open 2025 compared to the start of 2024 (a three-month yield that is 1.09%-points lower and a 10-year yield that is 0.69%-points higher than the start of 2024). We know 10-year yields have been climbing with some momentum, but that’s a nice head start for intermediate Treasuries versus the start of last year. Also keep in mind that when the 10-year Treasury yield peaked in October 2023, the fed funds rate was a full percentage point higher and trailing year core CPI inflation was still over 4%, conditions that are much more conducive to higher rates than what we have today.
Source: FactSet Research Systems
4 Policy Mistakes That Could Undermine Our Bullish Policy Outlook
“If pro is the opposite of con, does that make progress the opposite of Congress?” -famous quip
The 119th Congress was sworn in last Friday, with Republicans taking over majority leadership in the Senate and holding onto the House with the narrowest majority in the history of the Republican party. We thought that made it a good time highlight the potential policy mistakes that could undermine our otherwise bullish policy outlook for 2025. Policy mistakes could come from a lot of different places: the incoming Trump administration, Congress, the Federal Reserve, or even the Supreme Court. We review the ones that we think could have the greatest market impact below. Keep in mind that our sole focus when discussing policy is its impact on markets, and there certainly can be reasons to favor or criticize particular policies outside of that.
Our general view is that lower taxes, deregulation, higher fiscal deficits, and lower interest rates are all policies that tend to have a positive impact on corporate profits, which in turn support stock gains. There’s also the added factor of a rebound in the subdued economic confidence we’ve seen in recent years. Lingering pandemic fatigue and inflation spiking to its highest level in over 40 years in mid-2022 significantly dampened economic sentiment. In response to that, voters ousted incumbents at a high rate in 2023 and 2024. Left or right, if you were in power during the period of high inflation, voters said it was time for a change. In the US, confidence has been low despite economic growth over the last eight quarters surpassing anything experienced during either the Obama or Trump administrations (outside the immediate reversal of the pandemic recession). Change for the sake of change when there’s perception of a slump may be an added policy benefit.
But while we think the policy environment will be favorable, it is also not without risks. In fact, much of the risk is just from the opportunities failing to materialize. Keeping that in mind, here’s our survey some of the key policy risks markets may face in the year ahead.
Risk 1: The Federal Reserve Keeps Policy Too Tight
The first risk is not related to the Trump administration or Congress at all, but rather the possibility that the Federal Reserve keeps monetary policy too tight. The Fed is currently in a rate cutting regime, but expectations of the pace of rate cuts have slowed quite a bit. Shifting expectations is mostly due to improved growth expectations, which is a positive, but also a significant rise in inflation expectations, which we think is misplaced. The Fed’s perception of both inflation uncertainty and the direction of inflation risk changed substantially from September, as shown below, and that has led to greater caution around rate cuts.
Remember, a fed funds rate target of just 2.25 – 2.50% nearly broke the economy in 2018 – 2019, something President Trump correctly pointed out at the time, and low rates, even after some tightening, were still a major tailwind. Well, right now the target fed funds rate target is at 4.25 – 4.50%, two full percentage point higher. The economy has been incredibly resilient despite high rates, but cyclical sectors, including housing, small businesses, and manufacturing, have been under pressure and the labor market, while still strong, has exhibited some underlying risk, although it remains quite stable for now. Productivity growth, which is supported by a tight labor market and has been an important contributor to recent growth, may also be damaged by policy that is too tight if it leads to a rise in layoffs.
We think the current expected slower path of rate cuts is very unlikely to push the economy into a recession on its own, but it will make the economy more sensitive to other shocks. A slower path of cuts also means the incoming Trump administration will need to be more careful about policies that would raise concerns about inflation.
Risk 2: Tariffs Push Inflation Higher
There has been a lot of speculation about tariff policy but we expect the Trump administration will have some sensitivity to the potential impact on inflation and will keep tariffs at least somewhat targeted. A strong dollar, partly in anticipation of tariffs but also due to growth rate differentials between the US and other developed economies, can also act as an inflation buffer. For now, we think the concerns about tariffs and their impact on inflation are being overplayed. Nevertheless, even expectations of higher inflation can actually cause inflation and the Trump administration will have to be careful about how it communicates policy. As a result, credible saber rattling to strengthen the US negotiating position on tariffs could be damaging even if followed by more sensible actual policy. At this point, inflation expectations remain well anchored, but it’s a delicate balancing act. While we are suspending judgment on tariffs until we see what gets implemented and tilt moderately optimistic on the actual inflation impact, the potential for a policy mistake is there.
The S&P 500 fell over 6% in 2018 as the Fed tightened policy, and the trade war was raging. We’re still optimistic about markets in 2025, but the path of interest rates and uncertainty around tariffs are risks, and they are not the only ones.
Risk 3: Internal Division within the Republican Party Delays or Limits Policy Implementation
This is a policy risk that has a positive side. We noted during the election that markets tend to like mixed government. The spirit of compromise tends to get us better policy and helps avoid the ideological excesses of both parties. But we won’t have mixed government in 2025. When the new Congress was sworn in Friday, Republicans held narrow majorities in both the House and Senate. As of inauguration day on January 20, we’ll also have a Republican president in the Oval Office.
The majorities will be narrow. Republicans will hold a 53-47 majority in the Senate, as well as the tie-breaking vote by the vice president after January 20. Republicans would have held a 220-215 majority in the House, but Florida Republican Matt Gaetz resigned and two Republican House members will take positions in the Trump administration. That will make the Republican majority 219-215 until the members assuming new roles resign and then 217-215 until special elections can be held. (Unlike the Senate, replacements in the House can’t be appointed, only elected.) There is no tie breaker in the House, so at that point Republicans will not be able to lose even a single vote in the House when a vote is along party lines.
We did not get divided government, but there are ways in which narrow majorities keep at least some of the spirit of divided government. Republicans will need their own moderates AND their most hardline conservatives to vote yes to pass policy. If Freedom Caucus members hold up a bill, some Democrats could potentially be pulled on board to support it if they believe it is in their interest, but it would require some compromise. If Republican moderates hold up a bill due to it pushing too far to the right, it’s very unlikely Democrats will come to the bill’s rescue
We saw this in action with the current House’s recent efforts to fund the government. Republicans needed some Democrats to support the bill. Trump intervened using the bully pulpit as president-elect to object to the initial bipartisan continuing resolution (CR). But 38 Republicans rejected Trump’s alternative. A somewhat stripped down version of the original CR was finally passed with more Democratic votes than Republican. Trump’s interventions did lead to some changes, but the overall effect was small. From the perspective of the current House, a narrow majority led to compromise, although things will be somewhat different once Republicans control the Senate and Trump has been inaugurated.
Narrow majorities keep more checks and balances in place, but they also increase the possibility of legislative chaos and will make it more difficult to pass any bill that doesn’t have broad consensus among Republicans. Significant delays that disappoint policy expectations could lead markets to become impatient with congressional infighting. Keep in mind that Congress will have to deal with raising the debt ceiling and government funding in Q1 2025, let alone the important fiscal cliff associated with expiring individual tax cuts at the end of 2025.
Risk 4: Immigration Policy Stunts Economic Growth
In our view, this is the most underrated risk but still secondary to tariffs and monetary policy when it comes to the absolute level of risk. Clearly there are some genuine problems with current immigration policy. But the extent to which the resilience of the US economy depends on its ability to attract and absorb global labor is often underestimated. In fact, we would say the two key factors that have led to the structural advantage the US has had over other developed economies is a more business-friendly overall policy environment, including labor market flexibility, and its history of acting as a destination of choice for immigrants.
It’s hard to determine the level at which tighter immigration policy becomes a genuine risk, and before it becomes a risk there certainly may be areas where reforms would provide benefits. The aim here is not to determine what the right immigration policy should be (we are not policy analysts), but just to highlight that at some point tight policy can become a significant risk.
Here are just a few of the reasons immigration policy could pose a risk from an economic perspective:
-If the current level or flow of earners falls due to immigration policy and the chilling effect on new immigration, there’s a direct impact on GDP. A dollar of income lost is a dollar of GDP lost. Policy that leads working immigrants to leave the US, or choose not to come in the first place, is the economic equivalent of exporting U.S. GDP growth to the rest of the world.
-There is a steep implicit regulatory burden on business from tight immigration policy, both by restricting their access to workers and making the cost of labor higher.
-A more restricted labor pool also has the potential to drive wages higher, posing some additional risk for inflation. This effect may be stronger with the prime age participation rate already near a record high. We think this risk is fairly small, but not non-existent.
-Demographics are destiny. Immigration has been the US’s best defense against the challenges of an aging population. According to United Nations data, the old-age to working-age dependency ration in the US in 2022 was 29.4 (29.4 people aged 65 or older for every person aged 20-64). This ratio is important because current workers pay for the Social Security and Medicare benefits of current retirees. For comparison, the dependency ratio in 2022 was 38.0 in Germany and 55.4 in Japan. For the US, that number was 14.9 in 1952. In 2052 it’s expected to be 49.1 The US fertility rate in 2022 was 1.8, a level at which immigration becomes a larger factor in changes in the dependency ratio.
-There are certain areas of the economy that are hit particularly hard by tighter immigration policy. Since the election, housing stocks have fallen considerably despite overall strength in the consumer discretionary sector. This is largely due to higher rates but expected immigration policy is likely also a factor. At the same time, prices of agricultural commodities have been rising, again with multiple factors in play.
Immigration reform is a positive goal, but also comes with some risks. How high those risks are depends on actual policy. It would take a fairly large mistake to have enough of an impact on the economy to weigh on markets, but the potential for a large mistake is non-trivial.
There you have it, four policy risks that we’ll be watching for in 2025, with tariffs and the path of interest rate policy the most meaningful. Our view remains squarely in the camp that policy remains a tailwind, but Donald Trump was elected to be a disruptor, and while disruption can be valuable, it also can often come with unintended consequences.
This newsletter was written and produced by CWM, LLC. Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. The views stated in this letter are not necessarily the opinion of any other named entity and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.
S&P 500 – A capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
The NASDAQ 100 Index is a stock index of the 100 largest companies by market capitalization traded on NASDAQ Stock Market. The NASDAQ 100 Index includes publicly-traded companies from most sectors in the global economy, the major exception being financial services.
A diversified portfolio does not assure a profit or protect against loss in a declining market.
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