Multiple Expansion Drives 2024 Market Performance

In 2024, much of the 25% equity market return came from multiple expansion. Earnings for S&P 500 companies only grew about 10%, but the amount investors were willing to pay for those earnings (P/E multiple) expanded by about 16%. Thus, about two thirds of 2024 equity performance came from multiple expansion.

S&P 500: 2024 Performance Can Be Attributed To…

Usually, investors are willing to pay more for a company’s earnings when interest rates are low or falling. So the rise in the P/E ratio was surprising given bond yields rose about 0.5% by the end of the year.

This multiple expansion brought the market to historically high P/E levels (over 22), which is cause for concern going into 2025 unless we continue to see strong earnings growth.

The Magnificent Seven Strikes Again

Last year, diversified portfolios suffered versus the S&P 500 (SPY) as the market became more concentrated and the biggest stocks outperformed.

In 2024, the Magnificent Seven represented 34.6% of the S&P 500, up from 30.1% in 2023. To put this in perspective, the Magnificent Seven were already roughly equal to the size of the Japanese, Canadian, and UK stock markets combined at the beginning of 2024.

So yes — trees did grow to the sky.

In the chart below, the price/earnings (P/E) multiples of the top five companies reached 31.2 (gray line), while the median S&P multiple was 18.6 (blue line). While expensive, these levels are still below dot-com bubble extremes from 2000.

Why the Magnificent Seven dominate

While animal spirits (optimism) clearly contributed to multiple expansion, there are structural reasons behind the rise of the Magnificent Seven.

As Mihir Desai of Harvard Business School explains:

“Global investors have come to see the equities of these seven companies as the premier safe assets… in a world of inflationary spikes, political instability and fiscal uncertainty… investors view these companies almost like governments.”

In this view, mega-cap tech companies function like quasi-sovereign assets due to:

• Fortress balance sheets
• Recurring revenue models
• Stable cash flows
• Market dominance
• Trusted leadership

Equity Outlook

Looking ahead to 2025, we believe the odds of another major multiple expansion in the S&P 500 are low. Instead, we are focused on earnings growth.

Because software underperformed semiconductors in 2024, we shifted our technology exposure from semiconductors toward software companies.

We remain overweight software in 2025, as valuations remain inexpensive relative to history. As AI adoption accelerates, software companies are expected to be key beneficiaries.

Fixed Income Trends

Bonds experienced broad volatility in 2024 due to:

• Fears of economic slowdown
• Expectations of Fed rate cuts
• Concerns over Treasury supply and U.S. debt issuance

In the end, the U.S. Aggregate Bond Index (AGG) finished slightly positive.

However, both cash and gold significantly outperformed bonds over the year.

2025 outlook

We expect:

• Sticky inflation
• Slow Fed rate cuts
• Continued money market yields near ~4.25% through mid-year

On the long end, Treasury issuance may be temporarily constrained by the debt ceiling, potentially moderating early-year rate pressure.

Gold Outlook

Gold has performed well as an uncorrelated asset versus stocks and bonds.

It continues to serve as:

• A geopolitical hedge
• An inflation hedge
• A diversification asset

Recent strength has also been supported by foreign central banks increasing gold holdings to diversify away from the U.S. dollar.

We continue to maintain a gold position.

DeepSeek or Deepfake?

A Chinese AI model called DeepSeek recently gained global attention.

The DeepSeek-R1 model, released January 20, was reported to be significantly cheaper (20–50x depending on task) than OpenAI’s o1 model, according to DeepSeek’s WeChat statement.

This triggered:

• A selloff in AI infrastructure names (chips, utilities, power)
• A rally in software companies benefiting from lower AI costs
• A compression in AI-related valuation multiples

Skeptics Abound…

Some analysts question DeepSeek’s reported cost efficiency.

As reported by Reuters:

• Some estimates suggest training costs may be far higher than claimed
• Allegations include possible use of restricted high-end Nvidia chips
• True compute requirements remain unclear

Or… Cheaper AI Could Accelerate Everything

Others point to Jevons Paradox, where efficiency gains increase total consumption.

In this view:

• Lower AI costs → more AI usage
• More usage → more demand for compute
• Result → continued need for data centers and energy infrastructure

Ultimately, cheaper AI could:

• Accelerate adoption
• Boost productivity
• Potentially reduce inflationary pressure over time

Closing Thoughts

We expect 2025 to be an interesting and volatile year as dramatic government policy changes are both promoted and withdrawn.

Footnotes

[1] The Magnificent Seven: Alphabet, Amazon, Apple, Microsoft, Meta, Nvidia, Tesla

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