The State of the Markets (February 2025)

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This is a special edition of the Week in Charts where I break down the state of the markets…

1) Stocks

2025 thus far looks a lot like 2024. Which is to say the US equity market continues to hit new all-time highs with the S&P 500 up 4% year-to-date and 25% over the past year.

What’s propelling the market higher?

Two things:

a) Higher earnings: S&P 500 TTM operating EPS are on pace to hit another record high (75% of companies have reported Q4 earnings), up 9.5% over the past year.

b) Higher multiples: enthusiasm over the AI revolution has led to significant multiple expansion over the last year with the S&P 500’s price to peak earnings ratio moving up to 25.5. This is the highest valuation we’ve seen since June 2000, 48% above the historical median.

US stocks have outperformed International stocks for over 16 years, by far the longest run of outperformance in history.

But so far this year, we’re seeing the opposite, with International stocks up 6.9% vs. a 4.0% gain for the S&P 500.

We’re also seeing a quiet sector rotation as the broad market has continued to hit new all-time highs. Technology, the former leader for well over a decade, is the only sector with a negative return in the last 7 months.

Within Technology, Semiconductors had been the strongest industry group, outperforming everything by a wide margin. But that too has flipped, with Semiconductor relative strength peaking last June. Semis have actually underperformed the S&P 500 over the past year, a fact that would likely surprise many.

2) Bonds/Fed

While the S&P 500 continues to hit new all-time highs, the US Bond Market (Bloomberg Aggregate Bond Index) remains 8% below its peak from the summer of 2020.

At 54 months and counting, this is by far the longest drawdown in bond market history.

The story behind the long drawdown is a simple one: interest rates rising from 2020’s historic lows…

While many feared this would lead to a spike in corporate defaults, that never materialized.

In fact, the exact opposite is occurring. High Yield Spreads recently hit their tightest levels since June 2007 (2.59%). Bond investors are reaching for yield and behaving as if there will never be a default cycle again.

That has helped propel credit-sensitive areas of the bond market (High Yield, Leveraged Loans) to the top of the performance rankings over the past year. Meanwhile, duration-sensitive areas ($TLT, $ZROZ) are lagging due to the rise in long-term interest rates (30-year yield of 4.77%, up from 4.47% a year ago).

The rise in long-term interest rates has been highly unusual with the Fed cutting short-term rates by 100 bps last year (down to 4.25%-4.50%).

After the start of previous rate-cutting cycles, long-term rates either fell or were only slightly higher.

So why have longer-term rates been rising?

a) Inflation expectations have been moving up, with 5-year breakevens at their highest level since March 2023 (2.64%).

b) There was a huge surge in new debt issuance in the back half of last year with the US National Debt crossing above $36 for the first time.

For now, the rise in inflation has put the Fed on hold, and the market is only pricing in a single rate cut in all of 2025 (a 25 bps move down to 4.00-4.25%).

The good news for bond investors? Higher yields today will likely lead to higher long-term returns. We’re in a much different place than five years ago when interest rates were hitting all-time lows.

3) Real Estate/Housing

While the S&P 500 has hit 58 all-time highs since the start of 2024, Real Estate Investment Trusts ($VNQ ETF) remain over 8% below their peak from early 2022.

This is, in part, a result of the decline in US commercial real estate prices which are still down 18% from their peak 2022 levels.

Meanwhile, US residential home prices have continued to march upward.

The Case-Shiller National Index is at a record high, up 3.8% over the past year.

Home prices in the US are up over 50% in the last 5 years, more than double the increase in wages. The widening gap between prices and incomes has created an affordability crisis.

The median household income necessary to purchase the median home for sale in the US ($118k) is 49% higher than the current median household income ($79k). The most unaffordable housing market in history continues.

Naturally, this has led to a collapse in demand, with existing home sales in 2024 hitting their lowest levels since 1995.

So why are prices still going up? Supply remains extremely low as many would-be sellers can not afford to move.

Interestingly, while home prices continue to hit new highs, Asking Rents peaked back in 2022 and have now declined on a year-over-year basis for 20 straight months.

Rents have been held down by a multi-family construction boom that significantly increased supply and is leading to the highest vacancy rates (6.9%) since at least 2019.

4) Commodities

After a strong 2024 (+26.7%), Gold continues to hit all-time highs and is leading all major asset classes thus far in 2025 with a gain of over 11%.

Here’s a look at changes in the major commodity prices over the past year…

It’s a mixed picture with Crude Oil, Heating Oil, and Gasoline falling while Coffee is hitting record highs, up over 132%. Industrial Metals like Copper are showing a notable increase as well, up over 29%.

Today’s average for a gallon of gas in the US is $3.16, which is 6 cents lower than a year ago.

5) Currencies

The Dollar remains the strongest global currency and has sharply increased in value relative to the Euro and the Yen over the past 15 years.

Helping the Dollar retain its strength vs. the Euro and the Yen are two primary factors:

a) Tighter central bank policy in the US with a 1.4% real central bank rate versus 0.3% for the Eurozone and -3.1% for Japan.

b) A higher US growth rate with 2.5% real GDP in the US over the past year versus +0.9% for the Eurozone and +0.5% for Japan.

6) Crypto

Bitcoin surged to another record high in January, surpassing $109,000 for the first time.

It has since pulled back to $96,000, but is still up 94% over the past year, outpacing the 2nd biggest coin (Ethereum, +1%) by an enormous margin.

In outperforming most of its peers, Bitcoin’s share of the crypto market has moved up to 60% from 52% a year ago.

7) Stocks vs. Bonds

Stocks have trounced Bonds over the last decade with the ratio of stocks to bonds continuing to hit new highs in 2025.

Over the past 3 years, stocks and bonds have been more highly correlated (0.71) than any other 3-year period in history.

But correlation does not equal returns, as evidenced by the chart below which shows the S&P 500 up 45% in the past 3 years versus an 2% loss for bonds.

Over the past 7 years, nearly all of the 8.7% annualized gains in a 60/40 US stock/bond portfolio have come from the stock side, with the S&P 500 gaining 13.4% per year versus just 1.2% per year for bonds.

8) Economy

The US economy continues to grow, with annualized real GDP coming in at 2.3% for the 4th quarter.

The expansion is now 57 months long. Does that mean a recession is imminent? Not necessarily. The last 4 expansions in the US lasted a minimum of 73 months with the 2009-2020 expansion running for a record 128 months (over 10 years).

Economic growth is expected to continue for at least another quarter, with the Atlanta Fed projecting 2.3% in Q1 2025 and the Wall Street consensus above 2%.

The biggest concern continues to be persistently high inflation, with Core CPI running above 3% for 45 consecutive months. That’s the longest stretch we’ve seen since the early 1990s.

The good news is the labor market remains in pretty good shape, with a 4% Unemployment Rate that is still well below the historical average (5.7%).

We’ve now seen jobs growth in the US for 49 straight months, the second longest run in history.

Most importantly, wage growth of 4% in the past year was 1% higher than the increase in CPI inflation. That was the 21st straight month in which wages outpaced inflation over the prior year, a great trend for the American worker that hopefully continues.

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Disclaimer: All information provided is for educational purposes only and does not constitute investment, legal or tax advice, or an offer to buy or sell any security. Read our full disclosures here.

The post The State of the Markets (February 2025) appeared first on Charlie Bilello’s Blog.