What’s New

The holidays were far less happy for financial markets than the first 11 months of the year had been.

We came into the month with yields on the rise, and this continued into the inflation print that preceded the Federal Reserve’s (Fed) meeting in mid-December. The Consumer Price Index (CPI) ticked higher, and services inflation remains stubbornly high. This set the Fed up to deliver a more hawkish message, and they didn’t disappoint. The bond market has now dramatically repriced its expectations for rate cuts in 2025, with just under two cuts expected by year-end. This contributed to a significant steepening of the yield curve throughout the month. One consequence of the rise in yields has been the further strengthening of the US dollar. Keep in mind that this acts as a tightener in financial conditions, particularly in foreign markets. Positively, while credit spreads have widened modestly off their lows, they are far from levels that would be concerning.

Equities were mostly lower on the month. The S&P 500, Dow Jones Industrial Average, and Russell 2000 all closed down, giving back 2.5%, 5.3%, and 8.4%, respectively. The sharp move lower in the Russell 2000 stands out but is also unsurprising given the move in yields. The index is more reflective of the real economy and is comprised of many smaller companies, thus making it far more sensitive to the move higher in yields. The notable exception to the weakness came from the NASDAQ, which closed up roughly 0.5%. This was driven in large part by several familiar faces, and the Magnificent 7 finished the month over 6% higher.

The weakness in equities is somewhat unsurprising given the backdrop we had to start the month. Both sentiment and positioning were at extremes, with investors incredibly bullish, equity allocations near all-time highs, and cash balances near all-time lows. Valuations were unforgiving, with the market trading well over one standard deviation above its long-term average multiple. The combination of factors such as positioning, sentiment, valuation, rising yields, and a stronger dollar simply proved too much to overcome after a second consecutive year of incredibly strong gains in equities. Despite the weakness to close out the month, the S&P 500 delivered its second consecutive year of 20%-plus gains for the first time since the late 1990s.

Our Perspective

And this brings us to now.

We have talked at length before about how we believe investors should be prepared for an increase in volatility. We have no reason to feel any differently today. Despite their pullback to end the year, equities remain very richly valued, and sentiment continues to be elevated. We’ve said that markets are largely priced to perfection, and that remains the case today. While yields have risen, we see the tails as being fat, with a wide range of outcomes possible. We can make a case for yields to head materially higher due to an acceleration in growth and inflation, super-charged by fiscal spending and/or tariffs. On the flip side, we can just as easily make the case for a pronounced slowdown in growth that could see yields fall dramatically.

In such an environment, risk management is just as important as pursuing compelling investment opportunities. We believe that our active approach to investment management allows to prioritize both sides of the coin, and that’s precisely how we’re thinking today. While we anticipate that volatility will remain elevated, we’re confident that our processes arm us with the tools we need to navigate a challenging market environment.

Key Charts That Defined Markets & the Economy in 2024

A lot can happen in a year. We highlight 12 defining moments that shaped the current environment – setting the stage for what we believe is the slim margin for error in financial markets in 2025. See the year in charts here.

Our View

Economic Cycle		The US economy has remained resilient despite the aggressive hiking cycle we saw from the Federal Reserve. However, we did see pain in industries including transport and manufacturing. The US consumer has remained strong. We believe that the lagged effect of monetary policy could start to be felt in other parts of the economy in the coming quarters, and we are keeping a close eye on the labor market.
Stock Market		The US stock market continues to trade near all-time highs. Sentiment now appears stretched and valuations are not compelling. To date, market returns have been driven by multiple expansion. EBIT margins climbed to historical highs in the years following COVID lockdowns; elevated input costs and weakening demand and pricing power are posing a risk to the ability of corporations to maintain earnings at their projected level. Returns will be harder to come by and stock selection will be increasingly important.
Bond Market		While growth has remained resilient and inflation remains above target, interest rates have come in off of their peak as the market has started pricing in rate cuts from the Fed. Corporate spreads remain well contained, particularly considering the risks we see to the economy.
Important Issues on the Radar		Inflation: After a surprising uptick to start the year, inflation has resumed its downward trajectory. However, we would caution that we are still well above target and upside risks remain.
		China’s Economy: China has pivoted on key economic issues that acted as severe headwinds to growth over the last two years; however, economic growth appears to be stagnating and it will be critical to monitor the magnitude and the effectiveness of the policy response in the coming months.

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Source: Bloomberg.

All investments contain risk and may lose value. This material contains the opinions of Manning & Napier, which are subject to change based on evolving market and economic conditions. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

The Dow Jones Industrial Average is a price-weighted average of 30 blue-chip U.S. stocks that are generally the leaders in their industry. Dividends are reinvested to reflect the actual performance of the underlying securities. The Index returns do not reflect any fees or expenses. Index returns provided by Bloomberg.

The NASDAQ Composite Index is a broad-based capitalization-weighted index of domestic and international based common type stocks listed in all three NASDAQ tiers: Global Select, Global Market and Capital Market. The NASDAQ Composite includes over 3,000 companies. The Index returns do not reflect any fees or expenses. Index returns provided by Bloomberg.

The S&P 500 Price Return Index is an unmanaged, capitalization-weighted measure comprised of 500 leading U.S. companies to gauge U.S. large cap equities. The Index returns do not reflect any fees, expenses, or adjust for cash dividends.

The Russell 2000^® Index is an unmanaged index that consists of 2,000 U.S. small-capitalization stocks. The Index returns are based on a market capitalization-weighted average of relative price changes of the component stocks plus dividends whose reinvestments are compounded daily. The Index returns do not reflect any fees or expenses.

Index returns provided by Bloomberg. Index data referenced herein is the property of S&P Dow Jones Indices LLC, a division of S&P Global Inc., its affiliates ("S&P"), London Stock Exchange Group plc and its group undertakings (“LSE Group”)  and/or their third party suppliers and has been licensed for use by Manning & Napier. S&P, LSE Group and their third party suppliers accept no liability in connection with its use. Data provided is not a representation or warranty, express or implied, as to the ability of any index to accurately represent the asset class or market sector that it purports to represent and none of these parties shall have any liability for any errors, omissions, or interruptions of any index or the data included therein. For additional disclosure information, please see: https://go.manning-napier.com/benchmark-provisions.