Q4 2024 Market Update: A Resilient Economy Faces Mixed Signals

Key Takeaways

• The economy is growing modestly, supported by strong consumer spending and low unemployment.
• The Federal Reserve cut interest rates, with more reductions expected in 2025.
• Stocks performed well this quarter, while bonds offered limited returns.
• Lower inflation and interest rates could create new investment opportunities.
• A balanced portfolio remains key as we navigate an uncertain economic landscape.

Despite a mix of positive trends and mounting challenges, the economy and capital markets held up well over the past year, with the near-term prospects appearing positive. The economy is growing modestly, with declining inflation, historically low unemployment and growing wages. Yet, the damage inflation has inflicted on consumer pocketbooks and their psyche remains a headwind to growth.

While the services portion of the economy is humming along with record spending by consumers on air travel and entertainment, the manufacturing sector continues to struggle. Meanwhile, rising international conflicts and massive government deficits are a stark reminder of major challenges ahead.

For now, strong consumer spending, a rebound in corporate investment and a new White House administration should support economic growth and propel the capital markets into the new year.

Strengths and Struggles Across Economic Sectors

The data highlights a resilient economy, even as certain sectors are struggling due to reduced consumer demand and elevated market-based interest rates. On the positive side, the services sector remains in expansion mode, with 14 of 17 sectors reporting growth, led by food services, entertainment and health care. However, this growth is the weakest in three months, with companies expressing a cautionary outlook related to the election and proposed tariffs.

Employment remains another bright spot, with over 200,000 new jobs created in the latest month and an unemployment rate still at a historically low 4.2%. Still, the latest jobs report reveals some cracks: a decline in manufacturing employment, an uptick in layoffs in the technology sector and a lengthening in duration of those individuals on unemployment, the highest since May 2017.

On the negative side, the housing sector remains weak and volatile, weighed down by low inventories, high mortgage rates and a general affordability crisis. Although the Federal Reserve has started to lower interest rates, mortgage rates are still hovering around 7%. Also, at the current pace of existing homes for sale, there are 4.3 months of inventory – relatively low by historical measures – likely to keep home prices elevated.

Another sector still in the doldrums is manufacturing. Since late 2022, the manufacturing index has been below 50, indicating the sector is contracting. A general decline in consumer demand for goods, high mortgage rates and a construction slowdown are key factors. However, recent data shows signs of improvement: the latest factory gauge rose 1.9 points, the most since March, and new orders climbed 3.3 points, the most in five months, suggesting post-election optimism.

In short, the economy is growing modestly, supported by lower inflation and a reasonably good employment picture, but pockets of weakness remain.

Fed Policy and Market Performance in Focus

Amidst modest economic growth and declining inflation, the Federal Reserve cut short-term interest rates another 0.25% in November, following a 0.5% cut in September. Investors expect an additional 1% reduction by the end of 2025 to help maintain price stability and full employment. In this environment, stocks produced solid results for the quarter, while bond returns were generally lackluster.

The S&P 500 returned 2.39%, with mid- and small-cap stocks posting 0.33% and -0.59% returns, respectively. Growth stocks bounced back relative to value, while most international sectors saw weak results.

In bonds, slightly higher interest rates led to an Aggregate Bond Index return of -3.06%, while high-yield bonds returned 0.17% for the quarter.

What to Expect in the Year Ahead

Looking ahead, the economy appears in pretty good shape, supported by falling inflation and modest growth. The Federal Reserve is expected to continue lowering interest rates, albeit at a slower pace than previously thought due to sticky inflation data. Still, lower rates will help borrowers, stabilize prices and buoy the labor markets.

Despite somewhat elevated stock valuations, returns should prove solid in the year ahead. Meanwhile, moderating inflation and relatively high starting yields suggest bonds should deliver reasonable returns and help offset potential stock market volatility.