QUARTERLY MARKET UPDATE as of  January 2025

Another good year for the stock market.  The S & P 500 was up 2.7% in the fourth quarter and 17.9% for the year.  While technology and communication services remained the top performing sectors in 2025, most of the other sectors also had a good year with participation broadening out throughout the economy. Industrials, finance, healthcare, and utilities were all up over 10%.  For the quarter, the healthcare sector led the way with a strong 12% gain, while Real Estate lagged the market falling 3%. International stocks soared; the MSCI EAFE index was up 31.9% for the year, and 4.9% for the quarter; while the Russell 2000 small cap index increased 12.8% for the year, and 2.2% for the quarter.

Interest rates were mostly down in 2025. The 10-year treasury yield started the year at 4.5% and ended at 4.17%, while yields on the intermediate end of the curve declined almost 1%.  Both the 5-year and 2-year treasury yields are near 3.5% compared to 4.5% in 2024, the largest decline since 2020. The short term fed funds rate was cut three times by a quarter of a percent between September and December to end the year at the new targeted range of 3.5% to 3.75%, the lowest range in three years.  The 30-year treasury was the exception, with the yield remaining close to last year’s level at 4.84%. Concerns about an increase in government spending and lingering inflation are keeping a floor under the longer end.

Inflation has been coming down, but remains elevated.  The Fed’s 2% target inflation level has yet to be reached, and took a back seat to the focus on employment. The latest core personal consumption expenditures index rose by 2.8% on an annual basis, down from 2.9% from the prior month and a bit under expectations. The Fed expects inflation to continue trending lower, and has shifted its focus to supporting economic growth and maximum employment. This policy flexibility has been positively supported by the markets. A divided Fed however will be less likely to cut rates again this month, although a new Fed chair is expected in May with a policy bias to resume towards easing.

Jobs and growth surprise to the upside. The latest jobless claims report dipped below 200,000, a level that most economists associate with a tight or strong labor market. The labor force participation rate was little changed, and at 62.5% it reflects a steady labor force. The unemployment rate ticked up to 4.6%, but it is still at a relatively historic low level. The recent GDP report showed a surprisingly strong increase in the growth rate to 4.3% on an annualized basis, the most in two years.  Taken together, the employment and economic growth rates would suggest the Fed doesn’t need to lower rates again anytime soon. The stimulus provided by the rate cuts last quarter should serve as a tailwind for the markets and the economy this quarter.

Consumer sentiment’s influence on the economy is waning.  Historically, it has been regarded as a leading economic indicator, but that relationship appears to be severed. Monthly surveys over the past year have asked consumers what they expect the economy to look like in six months. The surveys have repeatedly predicted a recession which hasn’t occurred, and economists don’t expect one in 2026.  U.S. growth is projected to speed up as the initial impact from tariffs starts to fade, and greater certainty will help businesses with their budgets for hiring and investing. Lower interest rates will likely reduce borrowing costs again this year. This has helped the housing market which has been in the doldrums the last few years. Recent reports show strong increases in pending home sales and improved affordability driven by lower mortgage rates. Consumer spending has been solid, but higher income households have been driving the consumption, which helps explain the nuances in the sentiment reports. Lower income households have had a greater hit from elevated price levels and tighter credit, and have been less optimistic.

Earnings are expected to be strong. The FactSet forecast for this year has analysts projecting earnings to increase 15% for the S & P 500, and a 7.2% revenue increase, both higher than in 2025. The forward P/E ratio is 21.9, which is above the 10-year average of 18.7, but less than 22.8 recorded at the end of the third quarter. Valuations are rich, but not at extreme levels and in line with the relatively low-interest rate environment.

AI will help drive the economy forward. The AI boom over the last few years has directly benefited the mega cap big 7 tech-oriented stocks.  We expect the other 493 stocks in the S & P 500 will share in the benefits going forward, some more than others.  In healthcare for example new drug discovery and personalized medicine will be aided. AI will also accelerate discoveries in physics, chemistry, and materials science, aide in automation, optimize supply chains, and improve risk assessment for banks and insurance companies.

Market corrections can occur at any time, but the fundamentals still support optimism this year. We will maintain our focus on investing in higher quality companies with above average earnings and dividend growth.