Market Minute: Back-to-Back Years of Phenomenal Returns

This year has proved to be a great year for equity investors. With just days left in the trading year, U.S. equities are on track to post another back-to-back return of over 20%. Even after last week’s sharp correction resulting from the FOMC decision to cut rates by another 25 basis points, the bull market has yet to demonstrate a break of primary uptrend. While the short end of the Treasury yield curve has fallen along with the Fed Funds Rate since the September pivot on interest rate policy, long-term yields are notably higher than they were several months ago despite policy rates coming down. Widening of the yield curve is a sign of higher inflationary expectations resulting in the bond market commanding a premium for currency substitutes in the form of Treasury debt. As a result, the Fed communicated a more than expected hawkish stance on monetary policy next year due to slightly higher uncertain inflationary conditions. 

Despite the adjustment towards a more restrictive monetary outlook in 2025 as well as 2026, the markets appear to be focused on other beneficial factors to look forward to. The market follows the economy, and the economy is performing well which is bullish for stocks. Accommodative fiscal policy aided the U.S. economy during the Fed’s rate tightening campaign, and the possibility of favorable tax policy from the Trump administration can be construed as another form of fiscal generosity. Robust Infrastructure spending, and favorable protective trade policies may also be constructive in generating surplus profits for domestic producers of goods and services if implemented. 

While it is possible the broad equity market will surprise investors with another year of more than 20% returns, the probability of a normalized long-term rate of return may be a more rational and prudent expectation. Due to the uncertain policy framework implemented by the incoming administration as well as inflation which may not behave as anticipated, equity returns in 2025 may likely exhibit more volatility along the way.