November Market Commentary

In November, U.S. stocks surged, with the S&P 500 (1) and Dow Jones (1) recording their best months of the year. Investor optimism surrounding a pro-business second Trump administration helped drive gains, particularly in consumer discretionary and financial sectors. Year-to-date, financials and technology have led the market, each rising over 36%.

Inflation remains a concern, with the Consumer Price Index (CPI) increasing 2.7% annually and 0.3% monthly. Shelter costs remain a primary driver, up 4.7% year-over-year, while food prices climbed 0.4%. Though inflation has eased from its 2022 peak, it remains above the Federal Reserve’s 2% target. Markets widely anticipated the 25 basis-point Fed rate cut on December 18th as officials continue monitoring inflation trends.

The U.S. economy maintained steady growth, with Gross Domestic Product (GDP) rising 2.8% in Q3, driven by strong consumer spending and government expenditures. However, the labor market showed signs of slowing, with modest job growth, steady unemployment at 4.1%, and rising wage pressures.

Corporate earnings saw moderate growth in Q3, with S&P 500 companies reporting a 5.8% increase, as 75% exceeded estimates. Communication services and healthcare led earnings growth across sectors.

The housing market delivered mixed results. Existing home sales rebounded, but new home sales declined sharply. Mortgage rates remain elevated, averaging 6.78%, though lower than a year ago.

Outlook for 2025: Opportunities and Challenges

As we approach 2025, markets have been strong, reflecting optimism about a pro-business environment. Expectations for stable or lower corporate taxes and deregulation could boost corporate earnings, drive investment, and strengthen economic growth. If businesses and investors gain confidence in a favorable economic trajectory, a virtuous growth cycle of capital investment could ensue, benefiting employment, consumer spending, and innovation.

However, significant structural factors, including government debt, fiscal policy, and the balance between private and public sector activity, shape the broader economic picture. These key factors will heavily influence the trajectory of economic growth and market dynamics in the coming year and could contribute to heightened uncertainty among investors resulting in increased market volatility.

Government Debt and Deficit Challenges

Federal debt has soared to levels not seen since World War II, surpassing 110% of GDP during the pandemic. This is a dramatic shift from the more stable debt levels of 40% (+/- 10%) of GDP observed from the 1960s to the early 2000s. Major financial crises, such as the 2007-2009 debt crisis requiring large-scale bank bailouts and the unprecedented fiscal and monetary responses to the pandemic, have driven this sharp increase, as shown in the chart below.

The growing debt burden and ongoing deficit spending present significant challenges. High debt levels can crowd out private investment, elevate interest rates, and contribute to persistent inflation. Combined with
rising interest rates, federal debt service costs are climbing to historic highs. In 2024 alone, interest payments are projected to reach $892 billion (3.1% of GDP), with the Congressional Budget Office (CBO) forecasting this
figure to exceed 3.2% of GDP annually from 2025-2034 (EconoFact, CBO).

Efforts to address rising debt levels and spending will present challenges, and the outcome remains uncertain. This uncertainty may lead to cautious investor sentiment and amplify the potential for volatility,
as markets prefer clear and stable economic conditions. While managing the nation’s fiscal trajectory will require thoughtful solutions, it also creates an opportunity for policymakers to navigate a sustainable path forward.

Yield Curve Normalization

The inverted yield curve, where short-term rates exceed long-term rates, has restricted credit availability for small businesses, banks, and consumers. Consumers carrying credit card balances, auto loans, student loans, or seeking mortgages face higher interest costs driven by the Federal Reserve’s rate hikes to combat inflation. Small businesses reliant on short-term, floating-rate loans and lines of credit have similarly been
impacted. Additionally, the inverted yield curve has squeezed bank earnings by reducing profit margins on lending. Banks must offer higher interest to attract deposits but cannot lend at sufficiently high rates to maintain their required net interest spread.

The following charts illustrate the Federal Reserve’s rate hikes of 5.25 percentage points between March 2022 and July 2023, raising the policy rate to the 5.25%-5.50% range to combat rising inflation. After pausing,
the Fed began cutting rates in September 2024 with a 50-basis point reduction, followed by a 25-basis point cut on November 7th, 2024, and another 25-basis point cut on December 18th.

The recent cut brought the Federal Funds’ target range to 4.25%-4.50%, returning it to the level seen in December 2022. While investor consensus had anticipated this move, recent stickier inflation readings and evolving economic conditions have tempered expectations for further easing. According to the Fed’s closely watched “dot plot,” the central bank now signals it will likely implement only two additional rate cuts in 2025, reflecting a more cautious approach to monetary policy.

The Federal Reserve’s rate cuts have lowered yields on the short end of the yield curve, while expectations of persistent inflation and large Treasury bond issuances to fund the debt have driven up yields on the long end. The graphic below compares the yield curve shape from December 2023 to the present.

The red flatter line shows the yield curve as of December 16th, 2024. The maroon line illustrates the deep inversion in December 2023.  This flattening of the yield curve is progress; however, a normally shaped yield curve, where long-term interest rates are higher than short-term rates, indicates investor confidence in future economic growth.

A normal yield curve for banks and financial institutions supports profitable lending activity. They borrow at lower short-term rates and lend at higher long-term rates, earning a positive net interest margin. This
encourages lending, which fuels business investments, consumer spending, and overall economic expansion.

Conclusion

The federal debt and deficit pose significant challenges to sustained economic growth, requiring fiscal discipline to curb spending and monetary policies that encourage investment and long-term prosperity. The effectiveness of the new administration’s fiscal and regulatory strategies and its management
of geopolitical risks and trade policies will be pivotal in creating conditions that allow the underlying fundamental strength of our economy to thrive. A shift toward fiscal responsibility and reduced government involvement in capital allocation could empower a more dynamic private sector and broaden economic growth across industries.

The path to prosperity in 2025 hinges on implementing effective fiscal policies, inflation management, and the new administration’s economic approach to foster a supportive business environment. As Theodore Roosevelt
said, “Believe you can, and you’re halfway there.” It may be a big ask, but should progress be made on pro-growth policy, reducing deficit spending and debt, and further normalizing the interest rate environment, 2025
could bring renewed confidence and capital investment, spurring a virtuous cycle of economic growth. However, the journey to get there may be marked by ups and downs, highlighting the importance of staying focused on long-term investment goals. This is why we emphasize diversification and caution against making
sweeping changes in response to short-term market movements.

As the year comes to a close, we want to take a moment to wish you and your loved ones a joyful and restful holiday season. Thank you for your continued trust and partnership—it is truly an honor to help you work toward your financial goals. Your portfolio reports are available in your eMoney vault for easy access. Our offices will close early on December 24th and will be closed on December 25th and January 1st. Otherwise, we will be keeping regular business hours. If you have any questions or need assistance, please don’t
hesitate to reach out. Wishing you a wonderful holiday and a prosperous New Year!