4th Quarter 2024 Commentary

Contributed by: Brandon Bauer, CFP®

Market Performance Overview

  • Global stocks fell around 1% during the fourth quarter, with positive returns from US stocks offsetting weakness in international stocks. Bonds registered negative returns (-3.1%) over the same period, as rising yields pushed down bond prices.
  • For the year, stocks returned 17.5% globally, with U.S. large-cap stocks leading the way (up 25.0%). US small-cap and mid-cap stocks also posted strong returns (up 15.3% and 11.5%, respectively). International markets lagged domestic markets, returning 6.1%, as a strong dollar cut returns in half for US-based investors.
  • Despite a tough 4th quarter, bonds generated a positive return for the year (up 1.3%), with interest income offsetting price declines.

 


Economic Update

The economy proved resilient in the fourth quarter of 2024 despite uncertainty around monetary policy, a U.S. election, and geopolitical tensions. Third-quarter real GDP growth came in at 2.8% as consumer spending remained strong. Consumption makes up 70% of the US economy, so a healthy consumer usually translates into a solid economy. Business investment and government spending also contributed to growth, while weakness in home construction and softer imports were a drag on the economy.

Looking to next year, uncertainty around tariffs, immigration policy, and tax law has led to a range of potential outcomes for economic growth.

The new administration has committed to extending tax cuts and cutting costs. At the same time, they have outlined a plan to increase tariffs and dramatically lower immigration. The extent to which these policies will be implemented remains to be seen. These policy measures could be a source of inflation, with higher prices from tariffs accompanying expansionary fiscal policy.

Economic policymakers have a dual mandate focusing on stable prices and full employment. Inflation has moderated throughout the year, with the most recent reading at 2.7%. However, with some of the new administration’s proposed policies, there is concern around upward pressure on prices. Unemployment remains low, coming in at 4.1% in December. The Federal Reserve did cut rates by 0.25% in December as expected; however, they also made comments that pointed to potentially fewer interest rate cuts in the year ahead.


 

Equity Recap

Global stock returns were slightly negative during the quarter. A decline in international markets offset gains in US stocks. For the year, global stock returns followed up a strong 2023 with a return of 17.5% in 2024. US large-cap technology stocks led the way, as the “Magnificent 7” (Apple, Amazon, Google, Invidia, Meta, Microsoft, and Tesla) returned 48%, propelling a 25% return for the S&P 500. Earnings growth was solid in 2024 for US large caps, coming in at slightly over 11%. However, it is important to note that as the S&P 500 returned 20%+ this year and last year, around half of the price return was driven by higher valuations, while the other half was driven by earnings growth.

At this point, valuations for US large-cap stocks are quite elevated, nearing levels seen during the dot-com bubble. Although valuations are not a strong predictor for returns over the short run, high valuations have led to lower returns over the long run. Looking outside the “Magnificent 7”, earnings growth for the rest of the S&P 500 companies was softer, up 3% in 2024. However, in 2025, the earnings growth for these companies is expected to be 13%, while earnings growth for the “Magnificent 7” is expected to decelerate. Valuations for these companies are also much lower.

Looking outside the US, international equities struggled during the fourth quarter as a strong dollar reduced returns by 5.7%. The decline of around 8% for the fourth quarter reversed the solid momentum this market had been experiencing in 2024. International stocks currently trade at a valuation discount of close to 40% versus US stocks. International stocks have traded at a discount to US stocks due to their economic and currency risks, value tilt, and lower liquidity; however, the current valuation discount is twice what it has been on average over the last 20 years.

Going into 2025, earnings growth for US large-cap stocks is expected to be 14%, setting a high bar. With uncertainty around monetary and fiscal policy looming, the outlook for these stocks is less rosy than in prior years. We believe the case for diversification within equities is strong, given expectations for earnings growth to broaden beyond mega-cap tech stocks and more attractive valuations across small-caps and international markets.


 

Fixed Income Recap

During the year, the yield curve went from inverted (short-term yields higher than long-term yields) to a more normal, upward-sloping shape (short-term yields lower than long-term yields). This is important for investors to note, as the interest rate earned on cash is now lower than on a comparable bond with a longer maturity.

Longer-term interest rates incorporate investors’ expectations of where rates will be in the future. Over the last 12 months, investors’ expectations for where the Fed Funds rate will be 3-4 years out moved from around 3% to around 4%. This was a significant factor in increasing interest rates for bonds with maturities longer than 2 years.

Another factor driving rates higher is an expanding term premium. This is the extra yield that compensates investors for the additional risk taken when owning longer-maturity bonds. This drove a significant amount of the increase in the 10-year Treasury bond yield, which grew by 0.70% during 2024.

Currently, most bond sectors are trading at yields well above their median yield from the last 10 years. Although the extra yield received by investing in corporate bonds is low by historical standards, the all-in yield is attractive at north of 5%.

Despite a wider range of bond returns over the last five years, it is important to note that the current yield of bonds has been a good predictor of returns over the next five years. With yields around 5%, investors are receiving a solid return for investing in a safer asset class. Also, with inflation expected to be around 2.5% over the next five years, investors are expected to receive a real yield (interest rate minus inflation) of around 2.5%.


 

2025 Outlook & Beyond

As investors look beyond 2024, geopolitical tensions and uncertainty around monetary and fiscal policy remain. With the higher valuations produced by the strong investment returns of 2023 and 2024 thus far, it is more important than ever that investors maintain well-diversified portfolios designed to reduce risk and provide solid long-term income and capital gains. In an environment like this, it is crucial to take a diversified approach to portfolio management to mitigate unnecessary volatility or overexposure to a single risk factor. History shows that even at all-time highs, markets can still be attractive, as strong performance tends to beget more strong performance. If you are a client of our firm, we have created your portfolio to withstand all types of markets, such as 2022. If you are not a client and have not stress-tested your portfolio or do not have a well-designed plan to navigate uncertain times, perhaps now is the time to do so. We stand ready and available to assist you.

**Charts, graphs, market performance data, and commentary sourced from J.P. Morgan Asset Management, the Federal Reserve Bank of St. Louis, and Dimensional Fund Advisors.

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