Market Review
Post-election rally ends on U.S. government shutdown concerns
The post-election equity market rally paused in December as concerns over a potential U.S. government shutdown weighed on investor sentiment. The Russell 3000®, a proxy for U.S. equity performance, peaked on December 6 and then briefly dipped below its 50-day moving average mid-month, highlighting the heightened uncertainty. However, a bipartisan compromise on December 20 helped avert the shutdown, providing markets with some relief.
Meanwhile, concerns about the U.S. fiscal deficit gained traction, contributing to an upward move in long-term interest rates throughout the month. The rise in rates pushed the Bloomberg U.S. Aggregate Bond Index to its lowest level since late July, underscoring the headwinds facing fixed income markets.
Higher interest rates tend to exert downward pressure on equity valuations, and this dynamic was evident in December as only three sectors of the S&P 500® posted positive returns. The gains were concentrated in the Communication Services, Consumer Discretionary and Information Technology sectors, and were dominated by mega-capitalization (cap) technology companies.
In addition to the impact of rising rates, a strengthening U.S. dollar created additional challenges for international equities. The dollar’s ascent compounded existing pressures from geopolitical tensions, leading both the MSCI World ex USA Index and the MSCI Emerging Markets Index to remain below pre-election levels. These developments highlight the interplay of domestic and global factors that will likely continue to shape market performance into the new year..
Theme of the Month
The market’s New Year’s resolutions
Although in 2024, the MSCI All Country World Index delivered its best two-year return since the late 1990s, there are risks to continued strong returns in 2025. However, we maintain a constructive outlook for the new year as consensus expects global economic growth to remain positive and earnings growth to accelerate from last year. In our view, macroeconomic events in December were a microcosm of the issues investors should expect to face in 2025; therefore, this month’s themes are our New Year’s market resolutions.
1. Financial conditions matter more than the path of monetary policy
In 2025, one of the key lessons for investors is that financial conditions — not just the path of monetary policy — hold great influence on market outcomes. While central bank decisions often dominate headlines, it’s broader financial conditions, or the environment for credit availability, credit spreads and currency movements, that drive financial markets.
For example, from December 18, when the Federal Reserve (Fed) cut its policy rate by 25 basis points, through year end, the S&P 500 was only up 0.2%. While loosening monetary policy is typically a tailwind for equity markets, it was offset by unexpected tightening in financial conditions in December (Figure 1). In our view, conditions tightened due to a potential government shutdown, which catalyzed moves across several key market indicators. The U.S. Dollar Index hit a new one-year high on December 31, credit spreads for the Bloomberg Corporate High Yield Index hit a two-month high at year-end, and volatility, as measured by the CBOE Volatility Index, spiked mid-month to the highest level since the August 2024 selloff.
Figure 1. Goldman Sachs U.S. Financial Conditions Index
Despite a Fed rate cut, financial conditions tightened in December
As of 12/31/2024. Source: Bloomberg L.P.
View accessible version of this chart.
We continue to believe the path of policy rates remains important but matters less than the cumulative effect of financial conditions. For investors in 2025, this underscores the importance of looking beyond central bank meeting statements and press conferences. Tracking the broader mosaic of financial conditions provides a clearer lens through which financial markets and market leadership could evolve in the new year.
2. Valuation metrics should not be used as market-timing tools
Large-cap growth stocks led markets in December despite having a collective next-12-month (NTM) price-to-earnings (P/E) ratio of more than 30 times (x); rising long-term interest rates should have been a headwind for valuations. However, we believe these stocks have fundamental support from strong balance sheets and a positive earnings outlook despite the current environment of elevated inflation and high interest rates. Trying to wait for a better entry point would not have worked for investors in December.
Valuations should be viewed as a mosaic that reflects the current market environment, rather than as a timing tool for short-term trading. For example, the NTM P/E of the MSCI World ex USA Index is just 14.1x, and relative to the S&P 500, its NTM P/E is near the lowest level in the past 20 years. To some, that may imply developed international equities are cheap and warrant a significant allocation. In contrast, we believe developed international valuations are cheap for a reason, and their low relative level does not imply a bargain. The growth rate of the index is only 7%, revisions have been negative for months and even as the European Central Bank cuts its policy rate, economic activity remains subdued across most of Europe for a variety of reasons.
3. Volatility in an uptrend is a sign of a healthy market
For the first time since 2014, the S&P 500 was down in December despite a positive price return for the entire year. In years in which December was a down month, it was the third worst December in the past 20 years (Figure 2). Rest assured, December is not a harbinger for what’s to come in the new year, in our view.
Figure 2. S&P 500 20 Years of Down-month Decembers
The unique pullback in December is an opportunity, not a warning sign
Year |
December Price Return |
Annual Total Return |
2024 |
-2.5% |
25.0% |
2022 |
-5.9% |
-18.1% |
2018 |
-9.2% |
-4.4% |
2015 |
-1.8% |
1.4% |
2014 |
-0.4% |
13.7% |
2007 |
-0.9% |
5.6% |
2005 |
-0.1% |
4.9% |
As of 12/31/2024. Source: Bloomberg L.P.
Based on our analysis, we have a positive outlook for 2025 and believe investors should stay invested. Here are key takeaways related to the three prongs of our investment process:
- The business cycle has been in a slowing expansion phase for more than two years, and we believe there is a high probability that the cycle reaccelerates later in the year.
- Valuations remain rich relative to history; however, they reflect easing financial conditions and loosening global monetary policy. The Fed is not the only central bank cutting interest rates; except for Japan, every other major developed market central bank is loosening monetary policy.
- Technical indicators look similar to levels during the selloff in August 2024. The relative strength index for the MSCI All Country World Index is closer to oversold than overbought, and its 200-day moving average is still in an uptrend.
Our investment process points to an environment in which investors should seek to rebalance allocations that have materially moved from their targets, rather than get defensive. For long-term investors, a short-term pullback can present an opportunity to reposition for 2025 and beyond.
For more information, please contact your PNC advisor.
Figure 1: Goldman Sachs U.S. Financial Conditions Index (view image)
Despite a Fed rate cut, financial conditions tightened in December
Date |
Goldman Sachs U.S. Financial Conditions Index |
1/2024 |
99.35 |
4/2024 |
99.63 |
7/2024 |
99.11 |
10/2024 |
99.11 |
12/2024 |
99.33 |
As of 12/31/2024. Source: Bloomberg L.P.
Figure 2: S&P 500 20 Years of Down-month Decembers
The unique pullback in December is an opportunity, not a warning sign
Year |
December Price Return |
Annual Total Return |
2024 |
-2.5% |
25.0% |
2022 |
-5.9% |
-18.1% |
2018 |
-9.2% |
-4.4% |
2015 |
-1.8% |
1.4% |
2014 |
-0.4% |
13.7% |
2007 |
-0.9% |
5.6% |
2005 |
-0.1% |
4.9% |
As of 12/31/2024. Source: Source: Bloomberg L.P.
