Summary
Jumpy January: Our Monthly Survey of the Economy, Interest Rates, and Stocks In final two months of 2024, the stock market rallied in November on the election of Donald Trump and fell in December due to the more-cautious Fed tone following the December FOMC meeting. January 2025 had a bit of both as well, with stocks rising on optimism about a business-friendly climate and falling on seemingly unending tariff speculation. January also saw the usual index leadership turned on its head, with the bluest of blue chips beating the 'growthiest' of growth stocks. As of the end of the month, the DJIA had the best year-to-date return, the S&P 500 was in the middle, and the Nasdaq Composite was in distant third place. At the sector level, Communication Services and Consumer Discretionary -- two reliable growth sector leaders -- were out in front in January. But Information Technology was dead last, as the ripples from DeepSeek continue to upend earlier certainties that AI leadership is firmly in place in the United States. The Economy, Interest Rates, and Earnings The U.S. economy delivered below-consensus GDP growth in the fourth quarter, but still wrapped a solid 2024 year with high-2% growth for a second straight year. The advance (first) report of fourth-quarter GDP showed growth of 2.3%, below the 2.8% consensus level and a step down from 3.1% growth in 3Q24. Fourth-quarter 2024 GDP reflected ongoing growth in consumer expenditures and government spending, partly offset by a decrease in investments. Imports, which are a subtraction in the calculation of GDP, decreased quarter over quarter. Normally, fourth-quarter GDP would provide a window on what to expect from the economy in the first quarter. The policies of the new administration, however, are vastly different than those of the previous administration, lessening the likelihood of clear continuity. Analysis of full-year 2024 may indicate some of the longer-term trends that could influence the U.S. economy in the year ahead For all of 2024, U.S. GDP grew to $29.2 trillion from $28.3 trillion at the end of 2023. The consumer, as always, was the biggest growth driver. Personal consumption expenditures (PCE) for 2024 increased 2.8%, up from 2.5% for all of 2023. In the fourth quarter of 2024, PCE of 4.2% was the strongest of any quarter in the year. Full-year 2024 spending on goods increased 2.4% versus 1.9% in 2023. Durable goods spending rose 3.3% in 2024, down from 3.9 % for all of 2023. Nondurable goods spending rose 1.9% for 2024, more than double the 0.8% growth in nondurables spending in 2023. Spending on services was steady, with growth of 2.9% in both 2024 and 2023. Some of the growth in consumer services spending has been driven by rent equivalent, insurance, and other costs that consumers cannot control and many cannot avoid. Although services inflation has been more stubborn than goods inflation, tariffs can have an unpredictable impact on goods prices. Full-year 2024 consumer spending growth reflects a sub-par first quarter, acceleration in the second and third quarters, and moderating, but still strong, fourth-quarter spending. Consumers appear to be adapting to stubborn 'last-mile' inflation and structurally higher prices. We expect PCE within the GDP accounts to send ongoing and conflicting signals in 2025, with goods spending more volatile than services. Nonresidential fixed investment, the proxy for corporate capital spending, rose at 3.7% annual rate in 2024; this category grew at a 6.0% rate in 2023. PCE and nonresidential fixed investment represent about four-fifths of gross domestic product. In 2024, consumer spending added 1.87 percentage point to GDP, while nonresidential fixed investment added 0.50 percentage point. Residential fixed investment was somehow positive in 2024, rising 4.2% as double-digit growth in 1Q24 and surprising 5.3% growth in 4Q24 offset negative trends in the middle quarters. With the timing of any further Fed rate cuts uncertain, and with long Treasury yields returning to highs from spring 2024 (in the 4.6% range), the housing sector is more likely to recover in fits and starts than to burst into healthy growth. Offsetting rate pressure, however, is increasingly intense pent-up demand for home ownership. Exports grew 3.2% in 2024, and imports rose 5.2%. Although the export-import balance favored imports in 2024, both categories were negative in 4Q24. We expect quarter-over-quarter volatility in this category to become severe if U.S. tariffs are enacted for the long term and our trading partners react in kind. Another volatile category, the change in private inventories, added six basis points to 2024 GDP after subtracting 41 basis points in 2023 during the supply-chain crisis. Inventory-normalization disruptions to the supply chain have mainly receded. Higher tariffs under the incoming Trump administration could be another potentially disruptive factor. Overall government spending was up 3.4% in 2024 and added 56 basis points to 2024 GDP growth. Federal spending was up 2.5% last year, while state and local government spending grew 3.9%. The price index for gross domestic purchases increased 2.3% for all of 2024, compared with a revised increase of 2.9% in 2023. The PCE price index advanced 2.5%, down from 3.8% in 2023. GDP growth with lower price increases gives the Fed room to cut rates going forward. Outside the generally strong GDP accounts, the economic picture is mixed. U.S. economic data generally suggest some deceleration late in 2024 from early-year levels. Sentiment indicators across consumers, small businesses and large company purchasing managers suggest a mix of optimism due to pending deregulation and concern that tariffs will reignite inflation. The consumer economy continues to send mixed signals, with jobs and wages still growing, albeit at a slower pace. The U.S. economy generated 256,000 new jobs in December, above the consensus call of 16,000. Reflecting revisions to prior months, three-month average jobs growth of 170,000 was below the full-year 2024 average of 186,000; the 2023 average gain was 251,000 new jobs per month. While growth in new jobs continues to slow, multiple indicators of the employment economy -- including the unemployment rate, wage growth, and the average work week -- remained healthy into year-end. The unemployment rate was 4.1% in December 2024, better than 4.2% for November. Economists believe the jobs economy is in a 'low-fire, low-hire' phase. Average hourly earnings continue to grow at about 4.0% year over year. Annual wage growth continues to run above inflation, but the premium has narrowed. Industrial production ended 2024 on a strong note, rising 0.9% in December after gaining a revised 0.2% in November. For all of 2024, industrial production increased 0.5%. Full-year growth was driven by a 4.3% increase in utilities output. Manufacturing activity in 2024 was flat with that in 2023. Capacity utilization of 77.6% at year-end 2024 improved from 76.8% in November (the lowest since 2021), but declined from 78.1 at year-end 2023 and remained about two points below the long-run average. The National Federation of Independent Business (NFIB) Small Business Optimism Index reached a six-year high of 105.1 in December 2024 after rising to 101.7 in November, this on optimism regarding a change to a more business-friendly administration. November broke a string of 34 consecutive months below the 50-year average of 98. While small business owners are more optimistic, consumers appear to have some apprehension about the change in the presidential administrations. The University of Michigan Consumer Sentiment Index fell to 71.1% in January 2025 from 74.0 in December 2024 and well down from 79.0 in January 2024. Like the nation as a whole, consumers are divided on whether tariffs will help or hurt the economy and in particular whether or not they risk rekindling inflation. Consumers have become somewhat reconciled to higher prices. Retail sales rose 0.4% in December 2024 month over month and 3.9% from December 2023. That follows monthly gains of 0.7% in November and 0.4% in October. Personal income rose 0.4% in December, compared with growth of 0.3% in November and 0.7% in October; and personal consumption spending rose 0.7% in December after growing 0.4% in November and 0.3% in October. In the months before the Fed's first rate cut of the cycle in September, optimism returned to the long-depressed housing industry. After first coming down to multi-month lows following the September rate cut, market interest rates spiked higher in October-November and remained elevated at year-end. The effect of lower rates on housing will be positive. Given the huge number of homes with no mortgage and those with mortgages below 4%, however, Argus is not looking for a housing surge like that seen in the pandemic period. The Atlanta Fed's GDPNow model has a good track record, though it badly missed on 4Q24 GDP growth with a 3.1% forecast. The GDPNow model has a bold 3.9% growth forecast for 1Q25 GDP. Argus' Chief Economist Chris Graja, CFA, expects the final 2024 GDP growth rate to come in at 2.8%. Chris looks for GDP growth of 2.1% for 2025, and growth that is likely to remain near that level in 2026. The central bank started its rate-hiking campaign in March 2022. Sixteen months and more than five percentage points later, the Fed halted in July 2023 and held rates steady for eight straight meetings. At its mid-September 2024 FOMC meeting, the Fed cut interest rates by 50 basis points (bps). The central bank again cut the fed funds and discount rates, this time by 25 bps each, at its November and December 2024 FOMC meetings. That brought the tendency in the fed funds rate to 4.25%-4.50%, down 100 basis points from peak. The December meeting was accompanied by a statement suggesting that the pace of any future rate cuts would likely be pushed back in 2025. In January 2025, the FOMC met again and, as expected, took no action. Fed Chair Jerome Powell in post-meeting commentary stated that that the Fed 'was in no hurry' to enact any further rate cuts and that it might decide to hold rates at current levels across 2025. Where the Fed goes from here may require further progress on inflation, which is stubbornly stalled a half-point to a point-and-a-half above the Fed's 2% target range. The Fed is cognizant that tariffs are historically associated with higher goods price. Were inflation rise from current levels, we believe this Fed would not hesitate to return to a more-restrictive monetary policy and start raising rates again. CPI rose 0.4% in December 2024 and was up 2.9% from December 2023. The Fed's preferred inflation gauge, the core PCE Price Index, rose 0.3% in December versus 0.1% in November. This metric was up 2.6% year over year in December. The annual change has hardly moved from 2.7% in July. Bond yields hit multi-month lows following the Fed's September rate cuts and then moved higher soon after on solid economic data and economic optimism following the election. Yields first moderated off those spiky highs, then shot higher on the Trump election win. Both middle-maturity and long-maturity yields are now close to highs from spring 2024. The 10-year Treasury yield was 4.58% as of the end of January 2025, compared with 4.57% as of the end of December 2024, and 3.75% as of the end of September; the cycle peak was 4.9% in October 2023. The two-year Treasury yield was 4.22% as of the end of January 2025, versus 4.25% as of the end of December and 3.55% as of the end of September; the peak was 5.2% as of October 2023. Notwithstanding current noise in the market, Argus expects short-term yields to move lower from current levels. Long yields over time are expected to widen their relative premium to short yields. We likely have seen the end to twos-10s inversion in this cycle, but two- and 10-year yields could remain in proximity in the near term. While fully aware that the Fed is in 'no hurry,' Argus Fixed Income Strategist Kevin Heal continues to anticipate two or three additional quarter-point cuts in 2025, bringing the central tendency as low as 3.50%-3.75% by December 2025. He expects any cuts to be back-weighted to the second half of 2025. Still, it remains possible that the Fed holds rates unchanged in 2025, as it continues to monitor the economy, employment, and inflation. Following a successful 3Q24 EPS season, we increased our forecasts for S&P 500 earnings from continuing operations for 2025 and 2026. For 2025, we raised our forecast for S&P 500 earnings from continuing operations to $276, from $265. Our revised forecast models full-year EPS growth of 11.8%. For 2026, we raised our forecast for S&P 500 earnings from continuing operations to $307, from a preliminary outlook in the high $280s- to low-$290s range. Our revised forecast models full-year EPS growth of 11.2%. We will revisit our 2025 and 2026 EPS forecasts when the 4Q24 EPS season is in the books, but we are unlikely at this time to make major changes in our forecasts. The 4Q24 EPS season now in full swing, and we are seeing positive signs tempered with executive caution regarding the new policies emanating from Washington DC. With about one-third of companies having reported results as of the end of January 2025, fourth-quarter 2025 earnings from continuing operations are up in low-double-digit percentages from 4Q23. Of the companies reporting positive growth year over year, more than 77% have reported earnings ahead of consensus expectations. The magnitude of that beat has not been overwhelming, however. The average earnings 'surprise' for these companies is about 5%. By comparison, the average EPS beat against quarterly expectations has been in the 8%-9% range over the past five years and in the 6%-7% range over the past 10 years. For 2025 at the sector level, the key growth drivers are likely to be accelerating growth in Healthcare earnings; and improved performance from the three sectors (Energy, Materials, and Industrial) that dragged on 2024 earnings. Materials could swing to positive comparisons as soon as 4Q24, while Industrial may not get there until 1Q25. Energy could generate positive comparisons by 2Q25 or even 1Q25. We believe a return to sustained growth momentum for the commodity-sensitive Energy and Materials sectors will depend on the success of the Chinese government's stimulus program and other factors, including potential new tariffs. Other sectors are forecast to hold onto their current strong growth rates for the next year or more. Information Technology is forecast to sustain double-digit EPS growth in the mid- to high-teen percentages through 2026. Utilities growth is forecast to moderate but only slightly while remaining above long-term average, aided by AI data center demand for electricity. Other sectors forecast to grow EPS above their long-term averages include Financial, Healthcare, Consumer Discretionary, and Consumer Staples. For 2026, we look for a continuation of the above-average growth assumptions in our 2025 forecast, while moderating the overall growth outlook slightly. We expect the AI transformation to continue to drive growth in Communication Services, Information Technology, and Consumer Discretionary. We look for growth to slow in defensive sectors, but potentially to pick up in Energy. Domestic and Global Markets At the end of January 2025, the Dow Jones Industrial Average led among the three major indices with a 4.8% year-to-date gain after delivering a 15.0% gain for the 2024 year. The S&P 500 rose 2.8% in January 2025, after rising 25.0% in 2024. The Nasdaq, which finished 2024 up 29.6% on a total-return basis, was up a lagging 1.7% in January. Another reversal came as the Wilshire Large Cap Value is up 4.4% as of January end versus a 3.0% gain for the
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