4th Quarter, 2024
Investment risks continue to become more diverse.
THE MARKETS
For the second consecutive year the S&P 500’s total return exceeded 20%: 25.0% in 2024 following 24.2% in 2023. The forward P/E ratio is now 22.3x earnings, an increase of 10% from the end of 2023. These statistics suggest that while the market is not priced for perfection, valuations are high by historical standards. If one backs out the dominant Artificial Intelligence (AI) focus on the Magnificent Seven (Apple, Microsoft, Google parent Alphabet, Amazon, Nvidia, Meta and Tesla), 2024 market gains are closer to 15%. By contrast The STOXX Europe 600 returned 6% and the MSCI Asia gained 7.6%.
US equity markets moved up in the fourth quarter driven largely by continued resilience in the US economy, with GDP growth pushing above 3%, and post-election euphoria induced by hope of regulatory reforms, lower corporate taxes, and a continued surge of AI investment.
Monetary policy, while still restrictive, has begun to loosen. The Federal Reserve’s three cuts in the federal funds rate lowered the policy rate by a cumulative 1% as of year-end. The yield curve has shed its inversion, with a noticeable steepening at the long end since mid-year. Investor appetite has focused on the intermediate sector of 2-to-10-year Treasuries, eschewing higher yields on longer issues, reflecting uncertainty about long-term trends in deficits and inflation.
The post-election surge in the US Dollar has attracted significant inflows of non-dollar funds as predictions focus on continued widening of the global GDP gap. Recent forecasts show EU growth of just 0.8% in 2025, with China at 5% and India at 6%+.
Market participation has significantly broadened since the election with a notable increase in retail trading. The use of leverage and leveraged products continues to expand. This trend has included Cryptocurrencies which, like a racehorse, have taken the bit following positive signals from the incoming administration. Sector rotation is being shaped in large measure by the expected policy shifts (e.g. drill, baby, drill) that will come in on January 20th. We are likely to see ongoing volatility in growth stocks as long-term trends are challenged by short-term trading fancies.
Overall, a continuation of US economic resilience could support current market valuations. However, any sudden surge in negative sentiment on the course of interest rates and inflation may pause the current market momentum.
THE ECONOMY
The US economy has persistently surprised on the upside. Growth for 2024 is likely to end the year at 2.7%, up from 2.5% a year ago. As we begin 2025, the current trend of resilience remains in full swing as expectations of a business-friendly government policy take hold. Nonetheless, for the first time in many years we have a majority government which has the potential to make policy changes very quickly. In other words, be prepared for surprises that have economic consequences with attendant market volatility.
As we enter 2025, the global economy continues to diverge from that of the US. The European Union and United Kingdom are expected to post .8% GDP growth, 4.8% for China and 6.5% for India (slow by an emerging economy standpoint), portends a global slowdown which would likely be aggravated by any substantive US tariff initiatives. A downside scenario is an even wider growth gap, with the odds of recession in the EU compounded by electoral reform in Germany and France.
Here in the US, we will likely face more uncertainty if the new administration plays the tariff card. Tariffs are generally disruptive to established supply chains and act as a retardant to growth. A bilateral trade war is capital destructive and, hopefully, will be avoided.
The stated purpose of tariffs to enhance the tax code and achieve deficit reduction is questionable at best. Their impact on our present bout of economic resilience is uncertain.
The Federal Reserve’s December pivot from employment data back to inflation concerns and its suggestion that further cuts are off the table for at least the next six months appears to have ended the yield curve inversion and pushed long-term rates higher, as evidenced by the upward move in 30-year mortgage rates from 6.1% to near 7%.
Fed speakers are now suggesting that the new neutral rate is likely to be in the 3.0 to 3.25% range. Forecasts by some major institutional investors are predicting long treasury rates will move to 5 to 6% in 2025. Market sentiment appears to be concentrating on value in the two-to-ten-year range of the Treasury market with little interest in corporates; spreads are tight by historical standards and do not provide attractive compensation for credit and liquidity risk.
The employment picture appears to be consistent with the overall pace of the economy. Wage growth in heavily unionized sectors is running ahead of inflation expectations and would be an impediment should the economy suffer an unexpected growth shock. New job growth will likely slow until the new administration’s initiatives are well laid out.
INVESTMENT STRATEGY
Our primary objective is to maintain and increase the purchasing power of your portfolio by investing for long-term growth. As we enter 2025, we face investment risks complicated by political trends that have potential for broad-based economic disruption. Against this backdrop, we are assessing managements’ ability to successfully navigate geopolitical forces and events, while successfully advancing their corporate growth strategies.
Market volatility will likely persist and may increase in the present environment. When otherwise attractive investments become outsized and overvalued, it is prudent to harvest some capital appreciation and reinvest the proceeds for improved diversification in the portfolio.
Attractive entry points for new investment opportunities are not in great supply. However, they will emerge from time to time either from short-term market disruption, new technologies, or major changes in public policy. We continue to search for such opportunities.
Fixed income investment in US Government securities offers real returns of 1% to 1.5%. In historical context, these are attractive real returns. We continue to focus on short duration bonds of two to five years. Relative to Treasuries, corporate bonds are less attractive as the spreads remain very tight. The risk of corporate credit downgrades remains elevated in sectors such as commercial real estate and private equity.
With the markets close to all-time highs and numerous uncertainties in the offing, now is a good time to assess your capital and income needs for the next 12 months and work with us to make the necessary adjustments to your portfolios.
POINTS TO PONDER
Geopolitical forces can lie dormant for long periods. However, when they arise in bouts of realignment, they must be included in the calculus of overall investment risk.
In 2025 we will come face to face with three major global revisionary forces, two of which, Russia and China, have authoritarian and geographic agendas. The third is the US, which seeks to solidify its position as the dominant global economic superpower at the expense of others, even historical allies.
In addition, we are encountering a rapid right-leaning political reform movement in Italy, Austria, France, Germany and the UK where historically two-party systems are being swept aside by fragmentation leading to political instability with potentially negative consequences.
Regional conflicts continue in the Middle East with a power vacuum unfolding as Turkey and Israel vie for position in Syria, leaving the Kurds struggling for survival. In Asia, China continues its constrictive activities against Taiwan and exerts growing intimidation against Japan, the Philippines and Korea as well as menacing the integrity of our infrastructure at home.