By Daniel McGarvey, CFA, Senior Portfolio Analyst, on behalf of Stonebridge Financial Group advisors
Much like the year before, 2024 was a year in which market and economic expectations were generally exceeded. There were worries going into the year about election uncertainties, reignition of inflation, growing deficits, and market concentration, but none of those factors stopped the S&P 500 from setting new highs and returning 25%. There is some positive momentum heading into 2025, although the concerns listed above are, at least to some extent, still on the table.
For as impressive as stock returns were in 2024, bond returns were rather underwhelming. The Bloomberg US Aggregate Bond Index gained a tepid 1.3% on the back of a 10 Year Treasury Rate which rose from 3.9% to 4.6%. After spending most of the year in the 525-550bps range, the Federal Open Market Committee cut the Federal Funds Rate three times since September, and markets are expecting two more cuts in 2025. It was around when the Fed started cutting rates that the yield curve finally ended its longest inversion in history, and our sense is that this steepening will continue to unfold, but not drastically. Until we see significant economic weakness, there is little reason for the Fed to bring down the short end of the curve sharply. We also think the long end is somewhat anchored in the 4-5% range, and the main upward pressure it could experience is a resurgence in inflation.
Keeping inflation at bay will be a key battle for the new Trump administration, especially given its potentially inflationary promises of higher tariffs, lower corporate taxes, and dramatic immigration reform. Both interest rates and the US Dollar have risen in response to the election, and our sense is that those movements are justified. There is still considerable uncertainty about what the next presidency will hold, but we are also expecting reduced regulations, increased domestic manufacturing, and continued deglobalization. These trends should theoretically benefit smaller US companies and industries that are currently highly regulated, like financials and energy.
Although smaller companies should benefit from Trump’s policies, they are also often more economically sensitive. Our economy has proven to be quite resilient recently, bolstered by a strong consumer and labor market, but there is little room for significant improvement at this point, and leading indicators suggest a slowdown in the near term. Higher rates may still not have fully flown through the economy, and going forward monetary policy is unlikely to provide much of a boost.
For years we have voiced concerns over the growing deficit and debt levels, only for the bull market to march on as if nothing were the matter. The markets may continue to push the impact years into the future, but eventually the bill will come due. As shown below, the pace at which we are amassing debt has increased dramatically in recent years.
Any extent to which the new Department of Government Efficiency can make the government spend taxpayer money more wisely and efficiently is welcome, but there is a limit to how much spending can practically be trimmed when around 80% of the budget is composed of entitlements, defense spending, and interest expense. Coupled with the uncertainty regarding the continuation of the 2017 tax cuts and the feasibility of tariffs, the outlook for the deficit and the economy in general under the next administration is unclear and complicated.
The tariff situation also makes it difficult to assess international investments. Significant tariffs on China appear more likely and easy to enact than any that would be universal or targeted towards our more amicable trading partners, but even just the threat of tariffs can quickly move valuations and currencies. As a whole, foreign stocks have drifted downwards since the U.S. election, and they seem stuck waiting for clarity on policy implications. They are, however, quite attractively priced.
In sharp contrast, American equities have been on a fantastic two-year run but are now priced at historical extremes (see chart below). It could be argued that these prices are justified given the productivity enhancing potential of artificial intelligence (AI) or the years of stimulus, but they make us cautious enough to dampen our forward expectations. We still think the market can keep climbing with strong earnings results, but the pace that we’ve seen recently may be unsustainable.
Investment Allocation
Our philosophy of favoring high quality companies beyond just the handful of concentrated names at the top of the market has not changed throughout the year. We continue to be concerned by concentration risk and believe there is value to be found in parts of the market that don’t grab as many headlines. We have, however, added exposure to names that can be ancillary beneficiaries of emerging AI and infrastructure trends, which we doubt are going away any time soon. If AI is successful in revolutionizing productivity, it will require massive investments in energy that our current grids are not equipped to handle, along with the development of technology and equipment beyond just semiconductors.
As previously mentioned, the international space is quite complicated given tariff and immigration uncertainty, ongoing wars and trade dynamics, and the widespread expectation of deglobalization. We believe having international exposure is valuable, but we also find it prudent to use active managers who are familiar with the nuances of each market and know where the return potential is worth the risk.
On the fixed income side, we have been gradually increasing duration as the curve normalizes, but we remain cautious of taking undue rate risk in this environment. Similarly, we do not feel inclined to take on imprudent credit risk with spreads as historically tight as they are.
Lastly, we continue to see the benefit of holding alternative asset classes which add diversification benefits when stock-bond correlations are relatively high. Gold had standout returns in 2024, but we reduced some of that exposure due to a less certain outlook under the new administration. While it could benefit from increased trade tensions and inflation expectations, it could be weighed down by rising rates and a stronger dollar.
Charts and research provided by Strategas Research Partners, LLC.
Material discussed is meant for general/informational purposes only and it is not to be construed as tax, legal, or investment advice. Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary therefore, the information should be relied upon when coordinated with individual professional advice. Past performance is no guarantee of future results. Diversification does not ensure against loss. The opinions and forecasts expressed are those of the author, and may not actually come to pass. This information is subject to change at any time, based on market and other conditions.
Daniel is a Senior Portfolio Analyst at Stonebridge Financial Group and works on portfolio analysis and other related tasks. When away from the office, Daniel spends his time playing guitar, reading, and exploring the outdoors.
2024 Market and Economy Review and 2025 Look Forward
By Daniel McGarvey, CFA, Senior Portfolio Analyst, on behalf of Stonebridge Financial Group advisors
Much like the year before, 2024 was a year in which market and economic expectations were generally exceeded. There were worries going into the year about election uncertainties, reignition of inflation, growing deficits, and market concentration, but none of those factors stopped the S&P 500 from setting new highs and returning 25%. There is some positive momentum heading into 2025, although the concerns listed above are, at least to some extent, still on the table.
For as impressive as stock returns were in 2024, bond returns were rather underwhelming. The Bloomberg US Aggregate Bond Index gained a tepid 1.3% on the back of a 10 Year Treasury Rate which rose from 3.9% to 4.6%. After spending most of the year in the 525-550bps range, the Federal Open Market Committee cut the Federal Funds Rate three times since September, and markets are expecting two more cuts in 2025. It was around when the Fed started cutting rates that the yield curve finally ended its longest inversion in history, and our sense is that this steepening will continue to unfold, but not drastically. Until we see significant economic weakness, there is little reason for the Fed to bring down the short end of the curve sharply. We also think the long end is somewhat anchored in the 4-5% range, and the main upward pressure it could experience is a resurgence in inflation.
Keeping inflation at bay will be a key battle for the new Trump administration, especially given its potentially inflationary promises of higher tariffs, lower corporate taxes, and dramatic immigration reform. Both interest rates and the US Dollar have risen in response to the election, and our sense is that those movements are justified. There is still considerable uncertainty about what the next presidency will hold, but we are also expecting reduced regulations, increased domestic manufacturing, and continued deglobalization. These trends should theoretically benefit smaller US companies and industries that are currently highly regulated, like financials and energy.
Although smaller companies should benefit from Trump’s policies, they are also often more economically sensitive. Our economy has proven to be quite resilient recently, bolstered by a strong consumer and labor market, but there is little room for significant improvement at this point, and leading indicators suggest a slowdown in the near term. Higher rates may still not have fully flown through the economy, and going forward monetary policy is unlikely to provide much of a boost.
For years we have voiced concerns over the growing deficit and debt levels, only for the bull market to march on as if nothing were the matter. The markets may continue to push the impact years into the future, but eventually the bill will come due. As shown below, the pace at which we are amassing debt has increased dramatically in recent years.
Any extent to which the new Department of Government Efficiency can make the government spend taxpayer money more wisely and efficiently is welcome, but there is a limit to how much spending can practically be trimmed when around 80% of the budget is composed of entitlements, defense spending, and interest expense. Coupled with the uncertainty regarding the continuation of the 2017 tax cuts and the feasibility of tariffs, the outlook for the deficit and the economy in general under the next administration is unclear and complicated.
The tariff situation also makes it difficult to assess international investments. Significant tariffs on China appear more likely and easy to enact than any that would be universal or targeted towards our more amicable trading partners, but even just the threat of tariffs can quickly move valuations and currencies. As a whole, foreign stocks have drifted downwards since the U.S. election, and they seem stuck waiting for clarity on policy implications. They are, however, quite attractively priced.
In sharp contrast, American equities have been on a fantastic two-year run but are now priced at historical extremes (see chart below). It could be argued that these prices are justified given the productivity enhancing potential of artificial intelligence (AI) or the years of stimulus, but they make us cautious enough to dampen our forward expectations. We still think the market can keep climbing with strong earnings results, but the pace that we’ve seen recently may be unsustainable.
Investment Allocation
Our philosophy of favoring high quality companies beyond just the handful of concentrated names at the top of the market has not changed throughout the year. We continue to be concerned by concentration risk and believe there is value to be found in parts of the market that don’t grab as many headlines. We have, however, added exposure to names that can be ancillary beneficiaries of emerging AI and infrastructure trends, which we doubt are going away any time soon. If AI is successful in revolutionizing productivity, it will require massive investments in energy that our current grids are not equipped to handle, along with the development of technology and equipment beyond just semiconductors.
As previously mentioned, the international space is quite complicated given tariff and immigration uncertainty, ongoing wars and trade dynamics, and the widespread expectation of deglobalization. We believe having international exposure is valuable, but we also find it prudent to use active managers who are familiar with the nuances of each market and know where the return potential is worth the risk.
On the fixed income side, we have been gradually increasing duration as the curve normalizes, but we remain cautious of taking undue rate risk in this environment. Similarly, we do not feel inclined to take on imprudent credit risk with spreads as historically tight as they are.
Lastly, we continue to see the benefit of holding alternative asset classes which add diversification benefits when stock-bond correlations are relatively high. Gold had standout returns in 2024, but we reduced some of that exposure due to a less certain outlook under the new administration. While it could benefit from increased trade tensions and inflation expectations, it could be weighed down by rising rates and a stronger dollar.
Charts and research provided by Strategas Research Partners, LLC.
Material discussed is meant for general/informational purposes only and it is not to be construed as tax, legal, or investment advice. Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary therefore, the information should be relied upon when coordinated with individual professional advice. Past performance is no guarantee of future results. Diversification does not ensure against loss. The opinions and forecasts expressed are those of the author, and may not actually come to pass. This information is subject to change at any time, based on market and other conditions.
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