EQUITIES COMMENT – “2024 WAS A VERY GOOD YEAR--WHAT CAN WE EXPECT IN 2025?

2024 was a very good year for equity investors.   Stocks continued their ascent in the fourth quarter with the TSX Composite gaining 3.8% and the S&P 500 rising 9% in Canadian dollar terms.  This put the annual returns including dividends at 21.7% for the TSX and 36.4% for the S&P. 

What went right? 

Optimism about Artificial Intelligence (AI) continued to drive the S&P 500.  Technology, the largest sector, accounted for almost 40% of the gain.  If we include other AI leaders such as Google, Meta, Amazon and Tesla, together they contributed 55% of the S&P 500 rise. 

In Canada we had a similar story; Financials were responsible for 37% of the TSX return.  Here, interest rate cuts by the Bank of Canada and Federal Reserve had a positive impact.  Although interest rates declined, the rates on bank loans tend to reprice more slowly than on deposits so this allows “spreads” to widen and profits to increase.  (Lower rates also benefited dividend stocks in general and overall stock valuations.)   As well, Trump’s plan to reduce regulations for the sector are expected to result in higher profits.

Steady economic growth, about 1.1% in Canada and 2.7% in the U.S., provided a solid foundation for corporate profits to expand, inflation to decline and interest rates to be cut.

Inflation moved lower and is now running at about 2% in Canada however it is still above 2.5% in the U.S. 

Corporate profits expanded in both countries and are expected to finish 2024 with a 5% gain for TSX companies and 10% for S&P 500 firms.   

When Trump regained the U.S. presidency and the Republicans won a majority in both the Senate and House of Representatives, this virtually guaranteed a pro-business approach in government for the next four years.  Most importantly, there will be no increase in corporate taxes which is what the Democrats planned to do.

All but one sector in each of Canada and the U.S. had positive returns last year.  Technology was the leader in Canada (+38%) and a close second in the U.S. (+36%).  Financials outperformed in both countries with gains of 25%-28%.  Communications (+39%) was the top performing sector in the U.S. whereas in Canada, it was the worst with a loss of 27%.  (Tax loss selling in the fourth quarter further depressed the share prices.  See our previous Equities Comment for more details on the Canadian Communications sector performance.)  U.S. Communications stocks like Google and Meta are expected to profit from AI.  Other strong sectors in Canada included Energy (+18%) where lower interest rates had a positive effect on pipeline stocks, Materials (+19%) gained due to the rise in gold prices and Consumer Staples (+17%) benefitted from bargain hunters shopping more at discount stores.  In the U.S., Consumer Discretionary (+29%) was boosted by Amazon, Tesla and hotel and cruise line stocks.

What can we expect in 2025? 

Artificial Intelligence - Technology and AI leading stocks already reflect the potential of AI--whether it’s just some of it or a lot of it, we don’t know.  It would not be surprising to see these stocks take a pause until more concrete signs of the earnings potential are apparent. Because Technology makes up more than 30% of the S&P 500, a slowdown or correction in this group would have a significant impact on the broader market.

Interest Rate Cuts and Inflation – Due to slower economic growth and lower inflation, we expect the Bank of Canada to continue reducing rates.  The case for the Federal Reserve to reduce rates much more is less solid given higher inflation and growth as well as the inflationary impact of Trump’s tariff and immigration policies.  Tariffs will raise the cost of goods for consumers and domestic manufacturers; deporting immigrants could cause labour shortages and boost wages.  Already bond yields have risen in anticipation of more stubborn inflation in the U.S. If bond yields move much higher, they could start to have a negative impact on earnings and stock valuations.  Conversely, if Trump backs off his inflationary policies, continued rate cuts will benefit stocks.

Economic activity is expected to remain positive in 2025 however growth in Canada will be negatively affected by reduced immigration and the potential for new tariffs on goods traded with the U.S.  Further declines in interest rates will help cushion these developments as well as the recent increase in the unemployment rate.  In the U.S., fiscal policy should remain supportive.  It is generally expected Trump will not push tariffs to the point where they damage U.S. growth.  Consumers, the most important part of the economy, are in good shape.  Unemployment has increased but remains low and wages are increasing faster than inflation.  Lower interest rates are benefiting incomes while higher stock prices have boosted net worth.  Bottom line:  a recession in 2025 seems unlikely.

Earnings are forecast to increase 12% for the TSX and 14% for the S&P 500 in 2025.  Growing earnings were a key factor in the strong market performance of 2024.  If they materialize as expected in 2025, they should provide solid support for stock prices.

What about valuations?  The p/e multiple for the TSX has increased but remains very attractive compared to historical levels.  This contrasts with U.S. stocks where the p/e is at the top end of the historical range.  While the valuation for the S&P 500 is well above average, this has a lot to do with Technology related stocks that are experiencing very strong earnings growth.  Rising bond yields present a risk to p/e multiples.   If p/e multiples do not decline and earnings do not fall short of estimates, stocks should rise further in 2025.  Our targets are now 26,500 for the TSX and 6,400 for the S&P 500.  This would result in gains of 10% for both indexes including dividends.

Politics – A new prime minister for Canada that is more pro-business would be welcomed by investors.  Wars in the Middle East and Ukraine/Russia remain a risk for equities.  Disruption of the flow of goods such as oil could contribute to inflation.  Depending on how the major trading partners of the U.S. react to tariffs, economic growth this year could be put in jeopardy.

2024 was a very good year for patient, long term investors.    We expect markets to be more volatile this year primarily due to uncertainty surrounding Trump’s policies and the response to them.  To have a correction during the year would not be a surprise given the gains in stocks over the past eighteen months.  What can we expect for 2025? We expect further, albeit more modest, positive returns from both Canadian and U.S. stocks.