Market Activity
In the fourth quarter, U.S. equities stood out as one of the few asset classes to deliver positive returns globally. These gains were heavily influenced by the U.S. elections, where voters delivered a decisive result despite expectations of a prolonged and uncertain outcome. Post-election, markets responded with notable trends: U.S. equities outperformed international markets, the U.S. dollar strengthened, small-cap stocks outpaced large-caps, and longer-term yields rose. However, as the quarter progressed, some of these initial moves began to reverse.
For instance, U.S. equities surged nearly 5% during election week, but this gain tapered to just under 3% by year-end, according to Koyfin. Small caps saw an even sharper swing, climbing nearly 9% during election week before paring back to less than 2% by the close of the year. In contrast, international equities lagged throughout the quarter, weighed down by ongoing concerns over tariffs, and political instability and industrial sector weakness in Europe.
In the fixed income space, returns were negative as rising yields and falling bond prices were driven by both election outcomes and shifts in monetary policy. Policies such as tariffs, reduced immigration, and larger deficits are expected to contribute to higher inflation and an expanded supply of U.S. Treasury securities, further pressuring yields upward.
As the new administration takes office in Washington, investor attention will turn to the process of translating campaign promises into actionable legislation. These developments are likely to play a pivotal role in shaping 2025 asset class performance.
U.S. Economic Leadership and Outlook
The U.S. continues to lead the developed world economically, with GDP growth surpassing expectations. Third-quarter GDP rose 3.1%, following 3.0% in the second quarter, and the Atlanta Fed’s GDPNow model estimates above-average growth of 2.4% for the fourth quarter. These figures significantly exceed the Federal Reserve’s long-term GDP growth estimate of 1.7%–2.0%.
Several factors have contributed to this robust growth, including the healing of supply chains and steady immigration levels, which helped the economy expand without triggering wage pressures. Long-term GDP growth generally hinges on population growth and productivity, the latter measured as output per input (see accompanying “Sources of Population Growth” chart).
While population growth faces challenges, productivity has shown notable strength, growing at a rate of 2% or more for five consecutive quarters, compared to just two such quarters in the 20 quarters leading up to the pandemic. Many experts believe technological advancements will further boost productivity in the years ahead.
On the demand side, consumption remains resilient. Personal consumption expenditures (PCE) are set to post a third consecutive quarter of growth above 2.5%. The personal savings rate, after falling in 2022, has rebounded as consumers depleted excess pandemic-era savings. While consumer debt has risen, most spending growth is driven by rising wages. Jobs remain a key support for incomes, with current indicators like payroll additions and jobless claims signaling strength. However, leading indicators such as job openings, hires, and quits suggest continued moderation in 2025.
Globally, the U.S. stands out in a recent Organization for Economic Cooperation and Development (OECD) report, with its 2025 growth estimate revised upward to 2.4%, compared to a prior forecast of 1.6%. While China is expected to grow at 4.7%, this marks a slowdown from 2024 and remains far below pre-pandemic levels. Other major economies, including Germany, Japan, the United Kingdom, and France, are forecasted to grow at modest rates of 0.7%, 1.5%, 1.7%, and 0.9%, respectively. Outside the U.S., India emerges as a standout, with projected growth of 6.9% for 2025.
Monetary Policy: Federal Reserve Signals Additional Rate Cuts
The Federal Reserve has indicated the possibility of two additional rate cuts by the end of 2025, aligning with market expectations. During the December press conference, Fed Chair Jerome Powell remarked, “Some people did take a very preliminary step and start to incorporate highly conditional estimates of economic effects of policies into their forecast at this meeting and said so in the meeting.” This marked a sharp reversal from the Fed’s position in November, when it stated it would not base monetary policy on speculation regarding future fiscal policies. This shift was unexpected and somewhat shocking, especially for a central bank that prioritizes maintaining market confidence.
Valuation and Sentiment
Valuations have steadily expanded throughout the year, while credit spreads—the additional compensation investors demand for taking on credit risk in fixed income—have tightened. Although valuation is a poor predictor of short-term returns, elevated multiples require strong earnings growth to sustain them and increase downside risks if negative events such as geopolitical conflicts, inflation spikes, or pandemics arise.
Currently, above-average valuations appear justified, given the market’s expectation of 14% earnings-per-share (EPS) growth in 2025 and 13% in 2026. For comparison, the five years ending in 2019 saw an average EPS growth rate of 7.6%, according to Bloomberg, which aligns with historical trends. Meeting or exceeding these ambitious forecasts will play a critical role in determining equity performance in the years ahead.
Investment Outlook and Strategy – Our Responses to Common Client Questions
The Federal Reserve recently signaled a slowing of its easing campaign, citing concerns that overly robust economic growth could fuel higher inflation. While these concerns are understandable, we believe the economy is more likely to experience a gradual slowdown in 2025—characterized by continued growth at a reduced pace—rather than a full-blown recession or economic contraction.
This view is supported by several factors, including higher bond yields, unresolved challenges in commercial real estate, and the strength of the U.S. dollar. Additionally, the Goldman Sachs Financial Conditions Index, which reflects the impact of tighter financial conditions, has indicated a potential deceleration in real GDP growth during the first quarter of 2025. This deceleration is influenced by the recent surge in U.S. Treasury yields above 4.6% and a stronger dollar following the election.
It’s important to note that these indicators do not definitively signal a recession or a bear market. Instead, they suggest the likelihood of slower growth ahead. While this scenario could bolster bearish sentiment in equity markets if it cascades into a broader slowdown, we see it as more likely to represent a temporary deceleration rather than an outright contraction of the economy.
In our subjective assessment of financial markets, we estimate the risk to be above 5% but below 30%. While we do not endorse deficit spending, we acknowledge its political implications and have relegated this concern to a lower priority among potential disruptions.
Our perspective is rooted in historical data. Since 1977, U.S. GDP growth has averaged between 4.5% and just over 5% annually, while U.S. government debt growth has consistently outpaced it, averaging between 7.3% and 8.5%. These averages hold across multiple timeframes, including the past five, ten, and twenty years, as well as the entire 46-year period from 1977 to 2023 (please refer to the accompanying table).
Notably, there was only one year during this 46-year span when U.S. government debt growth nearly reached zero (the year 2000), registering a minimal increase of just 0.01%. This historical context underscores the persistence of deficit spending and its limited impact on GDP growth over time.
For the first time in 25 years, common stocks have posted returns exceeding 20% for two consecutive years. The last time we saw this remarkable milestone was during the 1998-1999 peak of the tech bubble, when internet-driven markets propelled valuations to unsustainable levels. Today, artificial intelligence has emerged as the key driver of rising stock prices, naturally leading investors to question valuations, particularly when prices trend downward.
In our view, there are significant differences between these periods, and both bullish and bearish scenarios may play out in the months ahead. We anticipate a meaningful pullback in stock prices in 2025, followed by sustained economic growth supporting markets over the next three to five years. A key reason for expecting a near-term pullback is current valuations—stocks are priced at 21 times expected earnings, with corporate profits projected to grow at double-digit rates in 2025. By contrast, the past two years of exceptional returns were achieved with only single-digit earnings growth, driven by rising price multiples. This dynamic suggests that a snapback in valuations is likely.
Despite these risks, we do not foresee a deep recession or bear market. Instead, the odds favor any significant decline as a temporary pullback within a secular bull market. As such, we recommend maintaining a defensive posture, keeping investable cash on hand to capitalize on opportunities, as policy uncertainty and higher valuations have heightened the market’s risk profile.
The SECURE Act 2.0 – Key Changes Coming in 2025
The SECURE 2.0 Act of 2022 introduced substantial updates to retirement plan rules, aiming to help Americans save more for retirement. While many provisions have already taken effect, several significant changes are scheduled for 2025. These updates are designed to enhance retirement security and expand access to savings opportunities. Below is a summary of the key changes:
Mandatory Automatic Enrollment
Starting in 2025, all new 401(k) and 403(b) plans established after December 29, 2022, must automatically enroll eligible employees. Initial contributions must be at least 3% and no more than 10% of the employee’s salary. Contributions will increase annually by 1% until reaching at least 10% but not exceeding 15%. Employees may adjust their contribution rate or opt out entirely.
Exemptions include:
- Companies with 10 or fewer employees
- Businesses with retirement plans established before December 29, 2022
- Companies operating for less than three years
Higher Catch-Up Contributions for Those Ages 60 to 63
Participants aged 60 to 63 will be eligible for enhanced catch-up contributions starting in 2025:
- 401(k), 403(b), and 457(b) plans: The greater of $10,000 or 150% of the standard catch-up limit (approximately $11,250 for 2025)
- SIMPLE IRA plans: The greater of $5,000 or 150% of the standard age 50 catch-up limit ($5,250 for 2025)
Plan sponsors may amend their plans to offer this option in addition to the existing catch-up contributions for participants aged 50 or older.
Expanding Coverage for Long-Term Part-Time Employees
Beginning in 2025, long-term part-time employees will become eligible to participate in 401(k) and ERISA-covered 403(b) plans if they:
- Work 500 hours annually for two consecutive 12-month periods
- Are age 21 or older by the end of the second period
This change helps include part-time employees previously excluded from workplace retirement plans.
The “Retirement Savings Lost and Found” Database
To help individuals track their retirement benefits, an online, searchable database will be launched by the Department of Labor (DOL). The database has a statutory deadline of December 29, 2024; however, concerns over false positives have prompted industry groups to suggest a delay or interim solutions.
As always, please don’t hesitate to reach out if we can assist you in navigating these changes or enhancing your retirement savings strategy.
DISCLOSURES – This presentation is not an offer or a solicitation to buy or sell securities. The information contained in this presentation has been compiled from third party sources and is believed to be dependable; however, its accuracy is not guaranteed and should not be relied upon in any way whatsoever. This presentation may not be construed as investment advice and does not give investment recommendations. Any opinion included in this report constitutes the judgment of Lincoln Capital Corporation as of the date of this report and are subject to change without notice. Additional information, including management fees and expenses, is provided on Lincoln Capital Corporation’s Form ADV Part 2. As with any investment strategy, there is potential for profit as well as the possibility of loss. Lincoln Capital Corporation does not guarantee any minimum level of investment performance or the success of any portfolio or investment strategy. All investments involve risk (the amount of which may vary significantly) and investment recommendations will not always be profitable. The investment return and principal value of an investment will fluctuate so that an investor’s portfolio may be worth more or less than its original cost at any given time. The underlying holdings of any presented portfolio are not federally or FDIC-insured and are not deposits or obligations of, or guaranteed by, any financial institution. Past performance is not a guarantee of future results. Lincoln Capital Corporation prepare presentation, 401.454.3040, www.lincolncapitalcorp.com Copyright © 2024, by Lincoln Capital Corporation.
