Investment Commentary Commentary – December 16, 2024

Equities

The S&P 500 returned -0.6% for the week. After the blistering year-to-date rally, markets were marking time for this week’s Fed meeting. Economic data showed a mixed picture: while the consumer price index (CPI) came in line with expectations, the producer price index and weekly jobless claims data both came in higher than expected. Communication services (+2.5%) and consumer discretionary (+1.4%) were the only sectors in the S&P 500 with positive returns; all other sectors finished in the red, with materials (-2.9%) and utilities (-2.6%) being the laggards. EAFE markets returned -1.5%, with losses in Japan (-1.8%) and Europe (-1.5%) leading the way down. EM markets returned +0.3%, with gains in Korea (+1.8%) and China (+0.5%).

From a valuation perspective, U.S. markets (other than midcaps) trade above +1 standard deviation based on historical forward P/E ratios as the S&P 500 is at +2.2, the NASDAQ is at +1.3 and U.S. small caps are at +1.3. For the next 12 months, EPS growth for S&P 500 is expected to be 10.5% (vs. 6.9% annualized over the last 20 years). For the next 12 months, EPS growth for NASDAQ is expected to be 20.6% (vs. 10.4% annualized over the last 20 years). For the next 12 months, EPS growth for the Russell 2000 is expected to be 27.8% (vs. 6.9% annualized over the last 20 years). All U.S. indices, including the S&P 500 (US Large Cap), NASDAQ, Russell Midcap (US Midcap) and the Russell 2000 (US Small Cap) trade at or above their 20-year averages based on forward P/E ratios while the MSCI EAFE (Non-US Developed Market Equities) and MSCI EM (EM Equities) are inline.

Fixed Income

Investment-grade fixed-income sectors posted negative returns, and rates rose sharply across the curve. Municipals returned -0.7%, US AGG returned -1.4% and U.S. IG returned -1.4%. HY bonds returned -0.2%, while bank loans returned 0.2%. EM debt returned -0.2% as the U.S. dollar rose 0.9%.

Rates

Rates fell rose sharply across the curve as markets pondered the path of future rate cuts. While a cut is widely expected this week, the pace and number of cuts in 2025 remain uncertain. The recession-watch 3M-10Y spread widened 33bps and closed the week in positive territory for the first time since November 2022. The 2Y-10Y spread widened 10bps to +15. Rates rose in other developed markets other than Japan. The BTPBund spread is at 1.14%. 5-year breakeven inflation expectations rose 9bps and now sit at 2.42% (peak on Nov 6 of 2.44% vs. low of 1.88% on Sept 10); 10-year breakeven inflation expectations rose 9bps and now sit at 2.35% (peak on Nov 6 of 2.40% vs. recent low of 2.03% on Sept 10); the 10Y real yield rose 15bps to 2.05%. The market now expects the Fed to cut once more in 2024 (Dec meeting probability at 97%) and three times in 2025 vs the Fed’s guidance of four cuts in 2025. At year-end 2025, the market expects the Fed Funds rate to be 3.8% vs. the Fed’s guidance of 3.25%-3.5%.

Currencies/Commodities

The dollar rose 0.9%. The commodities complex rose 3.1% as energy prices rose 5.6% for the week. Brent prices rose 4.7% to $74/bbl. U.S. natural gas prices rose 6.6%, while European gas fell -12.0% based on near term expectations for weather conditions.

Market monitors

Volatility rose for equities and bonds (VIX = 14, MOVE = 88); the 10-year average for each is VIX=18, MOVE = Market sentiment (at midweek) fell from 18 to 12 but showed that investors remain optimistic.