Stock Market Defies Expectations Again in 2024

How the market's resilience surprised economists and strategists
The U.S. stock market has once again defied expectations in 2024, posting remarkable gains despite high interest rates and rising unemployment. As we approach the end of the year, the S&P 500 Index is on track to close up more than 25% for 2024, one of its strongest annual performances in the last quarter-century. This unexpected performance has left economists and strategists scratching their heads, trying to understand what drove the market's resilience.

In this article, we'll explore the key factors that contributed to the stock market's surprising performance in 2024, backed by data and insights from Morgan Stanley's Global Investment Committee and Ameriprise Financial.

1. Higher interest rates didn't do much harm to the U.S. economy
Despite the Federal Reserve's aggressive rate-hiking cycle, the U.S. economy remained resilient, growing at a robust 2.9% in 2024. This economic strength was driven by two main factors:

- Alternative financing sources: The less-regulated "shadow banking" system, including private equity firms, provided alternative financing sources to businesses, helping to buffer the impact of Fed tightening. This allowed companies to continue operating and investing, which in turn stimulated economic growth and consumer spending (Morgan Stanley, Dec 23, 2024).
- Excess cash and reduced sensitivity to interest rates: Large corporations and affluent households typically hold excess cash and are less sensitive to interest rate changes. As a result, they were able to bolster the economy with continued spending, even as interest rates rose. This wealth concentration helped to maintain aggregate consumption and support economic growth (Morgan Stanley, Dec 23, 2024).

2. Rising unemployment didn't materially dent consumption
Historically, a rise in unemployment has been associated with a slowdown in consumer spending. However, in 2024, even as unemployment increased from 3.7% to 4.2%, overall consumer spending remained strong. This can be attributed to the wealth concentration among large corporations and affluent households, which typically hold excess cash and are less sensitive to interest rate changes (Morgan Stanley, Dec 23, 2024).

3. Traditional economic indicators were less predictive
The shift in the U.S. economy towards services has rendered traditional economic indicators, such as The Conference Board’s Leading Economic Index and the Institute for Supply Management’s manufacturing index, less effective in predicting economic trends. These indicators have been signaling contraction for some time now, yet the economy continued to expand, driven by the services sector and a shrinking number of increasingly dominant multi-industry companies (Morgan Stanley, Dec 23, 2024).

4. Easy financial conditions prevailed, despite monetary tightening
Even with the Fed's rate hikes and "quantitative tightening," financial conditions surprisingly eased. This was due to strategic moves by the U.S. Treasury to ramp up issuance of short-term Treasury bills, which money market funds quickly bought up, amid soaring investor demand for cash-equivalent yields above 5%. This deficit-funding maneuver helped keep ample cash flowing through the financial system, leading to easier access to credit for companies and consumers, even as monetary policies tightened (Morgan Stanley, Dec 23, 2024).

5. Equity valuations continued to expand, despite higher rates
The enthusiasm for generative AI and other innovations led to a significant concentration of market gains in a few mega-cap tech companies, pushing their valuation multiples higher. Typically, higher rates might leave such richly valued stocks vulnerable, but the strong performance of the tech sector helped drive overall market gains (Ameriprise Financial, Dec 16, 2024).

In conclusion, the stock market's resilience in 2024 can be attributed to a combination of factors, including the economy's ability to withstand higher interest rates, the strength of consumer spending despite rising unemployment, the shift in economic indicators, and the ease of financial conditions. As we look ahead to 2025, investors should remain vigilant and actively manage risks in their portfolios, as the economy and markets continue to defy expectations.