Stocks Surge, Bonds Fall, the Story of 2024
Dr. Bryan Taylor, Chief Economist, Global Financial Data
The bond rout that began in 2021 continued in 2024 while US stocks returned over 25 percent for the second year in a row. 2021 and 2022 were two of the worst years in bond market history as central banks in the United States and Europe raised interest rates to fight inflation. 2023 provided relief as bond yields steadied in anticipation of lower interest rates from central banks, but 2024 provided another down year for most fixed income investors as bond yields rose. While stocks have returned, on average, 14.5 percent during the past five years, bonds have lost 2 percent per annum. This works out to an annual equity risk premium of almost 17 percent during the past five years.
Bonds Sink for the Third Year of the Past Four
The anticipation that the Federal Reserve would dramatically lower interest rates in 2024 did not occur. The Fed only lowered interest rates three times in 2024 and the number of expected reductions in 2025 has been lowered to two. Consequently, the anticipation that interest rates would not decline as much led to an increase in bond yields and a decline in bond prices. While the yield on the US 10-year bond was unchanged in 2023, the yield rose from 3.88 percent at the end of 2023 to 4.57 percent at the end of 2024. This caused bond prices to drop by more than the amount of interest that bondholders received leading to a net loss for bondholders.
A similar increase in interest rates occurred in the UK where the British 10-year bond yield rose from 3.70 percent to 4.56 percent. In Germany, and in the rest of the Euro area, the increase in yields was smaller, with yields rising from 2.02 percent to 2.36 percent in Germany, causing a smaller decline in bond prices. However, the US Dollar appreciated against the Euro and most global currencies in 2024, so if you calculate the impact on US investors, whether you had your money in the United States or in foreign countries, in terms of US Dollars, you lost money on fixed income. Admittedly, the losses in 2024 were not as bad as the losses in 2021 and 2022, but they were still losses.
Figure 1. Index of the Total Return to the US Government 10-year Bond, 2005 to 2024
As Figure 1 shows, investors in the US 10-year bond have made no progress since 2015. Long-bond investors have not been able to earn any return for almost ten years now. On the other hand, stocks, especially in the United States, have done well during the past ten years. This means that the equity risk premium has hit levels not seen in decades. The S&P 500 Total Return index rose 25 percent in 2024 following a 26 percent rise in 2023. The decline in the bond index of 1.5 percent means that the equity risk premium was over 25 percent for the second year in a row. Since 2019, the ERP has been at its highest level in history.
Stocks Surge Ahead for the Second Year in a Row
The returns to stocks have been driven by the outperformance of the “Mag 7” stocks which now represent about one-third of the capitalization of the S&P 500. Figure 2 shows the percentage of the 10 largest stocks as a share of the 500 largest stocks until 1957 and the S&P 500 since 1957. The concentration in the US stock market is currently the greatest it has been in history.
Figure 2. 10 Largest stocks as a share of the 500 Largest stocks, 1875 to 2024
Meanwhile, the market capitalization of the US stock market is once again twice the nation’s GDP as can be seen in Figure 3. The impact of the strong performance of the stock market during the past ten years is clearly visible. How much higher this ratio will increase before it falls back, as it inevitably will, remains to be seen.
Figure 3. United States Market Capitalization as a Percentage of GDP, 1789 to 2024
The United States is in its second period of outperforming the rest of the world. If you look at Figure 4 you can see how the S&P 500 and GFD’s World excluding the United States Index have performed during the past 75 years. Between 1950 and 1982, there was little difference in the performance of the S&P 500 and the rest of the world. Global markets surged ahead between 1982 and 1986, but the United States outperformed the rest of the world between 1986 and 1998. The World x/USA outperformed the S&P 500 during the next ten years, but since 2008, the United States has clearly outperformed the rest of the world. The World x/USA Index is in the same position it was in 2008 while the S&P 500 has risen dramatically.
Figure 4. The United States and the World x/USA Stock Indices, 1950 to 2024
A similar result is obtained when you compare the S&P 500 to GFD’s Index of Emerging Markets in Figure 5. Emerging markets progress in surges but provide no returns in between these dramatic increases. Emerging markets did well between 1966 and 1971, 1984 and 1994, and 2002 and 2008. During the periods in between, Emerging Market stocks made no or little gains. In 2024, emerging market stocks remain below the peak they hit in 2008.
Figure 5. The S&P 500 and GFD’s Index of Emerging Markets, 1950 to 2024
The key to these periods of outperformance in the United States compared to the rest of the world and Emerging Markets is technology. During both the 1990s and during the past 15 years, technology has driven the US stock market higher. Although some American technology companies may be run by individuals from Emerging Markets, they are American companies. The Mag 7 companies, and other technology superstars have been able to penetrate every market in the world. By one estimate, 40 percent of the sales of American companies are outside of the United States. As long as the United States continues to dominate the technology sector, the United States stock market will continue to outperform the rest of the world’s stock markets.
The Outlook for 2025
Where do we go from here?
Donald Trump will become President on January 20. He has promised dramatic changes from the policies of President Biden. Trump has threatened to dramatically increase tariffs on goods coming into the United States, but the CEOs of the Mag 7 and other technology companies are working with Donald Trump to gain influence over his policy decisions. The stock market clearly shows that US companies have successfully penetrated the rest of the world. American technology companies are masters of the global market. To perpetuate the outperformance of American stocks over the rest of the world, American policy must continue to promote these companies. The focus should be on increasing American exports, not limiting imports. Meanwhile, concerns over inflation, either from an increase in tariffs or large government deficits have affected the Federal Reserve’s forecast and put the rapid pace of interest rate cuts on hold.
Clearly, there is a lot of uncertainty over government policy in 2025, but changes in government policy will influence the performance of both the stock and bond markets. Policies that limit inflation and promote exports will benefit the stock market and investors. Policies that promote inflation and limit trade will hurt investors. A year from now we will know if and how government policy has changed and how these changes impacted financial markets. Be prepared for what could possibly be a volatile year.
