Q4 2024: Thoughts on the Investment Markets

“In life, the challenge is not so much to figure how best to play the game; the challenge is to figure out what game you’re playing.” – Kwame Appiah

• Economic conditions continued to moderate in the fourth quarter as inflation crept marginally higher, though it remained below 3%.
• The Federal Reserve cut interest rates 25 basis points in December, bringing the total rate cuts in 2024
  to 1.0% (100 basis points).
• Large-cap growth stocks once again led equity markets higher in the fourth quarter.
• Bond prices declined as interest rates backed up, surrendering much of the year’s gains.

ECONOMIC REVIEW & OUTLOOK

Source: Factset; Bloomberg. Data from 10/13/2022 to 12/31/2024​

As 2024 drew to a close, economic conditions in the United States remained largely unchanged from the previous quarter. Real GDP growth was 2.7% in the third quarter, marking the seventh consecutive quarter that real GDP growth topped 2%. Real GDP has not posted a negative reading since the fourth quarter of 2020, despite persistent concerns of a looming recession that has stubbornly resisted to materialize. Inflation crept up in the fourth quarter, rising from 2.4% in September to 2.7% in November. Unemployment was relatively stable in the second half of the year, ranging between 4.0% and 4.3% from May to November, continuing to stay below long-term historical averages.

In response to the economy’s continuing strength and moderating inflation, the Federal Reserve (Fed) began cutting interest rates in September with a 0.50% rate cut, which lowered the federal funds target rate to a range of 4.75%-5.00%. The Fed followed up with additional 0.25% cuts in both November and December, bringing the federal funds rate to 4.25%-4.50%. In their December Summary of Economic Conditions, the Fed raised their inflation projections for 2025 from 2.1% in September to 2.5%, while also raising their expectations for future policy rates by 0.50% for both 2025 and 2026, to 3.9% and 3.4%, respectively.

It seems likely that going forward, the policies of the incoming administration will take up a lot of oxygen in public discourse. However, the exact nature of these policies, the timing of their implementation, and the ultimate impacts they have on the economy remain uncertain. The economy has remained strong as inflation has come down from its post-pandemic highs, which has been a boon to financial markets over the last two years. This should provide a solid base for the economy and markets moving forward, though the risks from geopolitical shocks are ever present.

BOND MARKET REVIEW AND OUTLOOK

Index return data provided by Morningstar Direct and Bloomberg. This information is provided for illustrative purposes only. Index performance does not reflect fees or expenses that investors typically pay to buy or sell securities. It is not possible to invest directly in an index.

Bonds sold off in the third quarter in response to rising interest rates and a fear that the Fed might not cut rates in 2025 as much as had previously been anticipated. Through the end of the third quarter of 2024, the Bloomberg U.S. Aggregate Bond Index was up 4.5% year-to-date, but much of those gains evaporated in the third quarter as intermediate and long-term interest rates rose in the fourth quarter. The 10-year Treasury yield was 3.81% at the end of the third quarter and rose to 4.58% by the end of 2024, while 30-year Treasury yields rose from 4.14% to 4.78% over the same timeframe.

Similar to long-term rates, short-term rates fell over the course of the year. The six-month Treasury ended 2023 yielding 5.26%, then fell to 4.24% by the end of 2024 in response to the Fed’s lower policy rates. This steepening of the yield curve, while producing negative quarterly returns for bond holders, may create a more attractive opportunity set moving forward for bond investors. The higher yields currently on offer create greater opportunities for capital appreciation should interest rates fall, since bond prices typically appreciate when interest rates fall. The higher yields also create a greater cushion of income for bond investors should interest rates rise. In addition, a steeper yield curve creates more “roll yield” for bond investors, as bond prices increase when bonds “roll” down the yield curve towards maturity. Despite negative-to-flat performance in the quarter for most fixed income securities, the higher-yield, lower-inflation environment today remains more favorable for bond investors than we have experienced over much of the past 15 years.

STOCK MARKET REVIEW & OUTLOOK

Index return data provided by Morningstar Direct and Bloomberg. This information is provided for illustrative purposes only.
Index performance does not reflect fees or expenses that investors typically pay to buy or sell securities. 
It is not possible to invest directly in an index.

The S&P 500 posted a second consecutive year of stellar performance in 2024, returning 25.0% following a return of 26.3% in 2023. This is the S&P 500’s best two consecutive calendar years of performance since 1997-98, when the annualized return of the S&P 500 was 30.9%. Stocks rallied in the fourth quarter, led by large-cap growth stocks. While growth stocks rallied, it was tougher sledding for value stocks. This can be seen in the fourth-quarter outperformance of the Russell 1000 Growth (+7.1%) versus the Russell 1000 Value (-2.0%). This continues a pattern that has dominated stock market performance during most of the post-pandemic period. Like the growth/value performance disparity, the S&P 500 (+2.4%) outperformed the Russell 2000 (+0.3%) as large-cap stocks continued their post-pandemic dominance over small-cap stocks, albeit by a narrow margin in the fourth quarter. Broadly, international stocks sold off in the third quarter after posting solid gains through the first nine months of the year.

While small-cap stocks have been laggards relative to large caps, there are reasons for optimism for smaller companies moving forward. Potential policy changes, such as a lower regulatory burden, lower interest rates, and more domestically focused trade policies may provide a more favorable environment for small companies. However, these potential positive tailwinds may be somewhat mitigated should these policies create trade conflicts that result in supply-chain bottlenecks or increased pricing of component parts or certain services due to the imposition of tariffs.

Setting aside the outsized impact of ~7 companies, international stocks have outpaced the U.S. market since the rally began in late 2022

Source: FactSet; Bloomberg. Data from 10/13/2022 to 12/31/2024. This information is provided for illustrative purposes only. Index performance does not reflect fees or expenses that investors typically pay to buy or sell securities. It is not possible to invest directly in an index. “Magnificent 7” technology companies include the following: NVDA, AAPL, MSFT, GOOG, META, TSLA, AMZN.

International stocks have lagged U.S. equities for much of the last 17 years. It may be tempting for investors to dismiss the opportunities available in global equity markets owing to this persistent underperformance. But performance differentials between U.S. and international equities have come in waves over the last 50+ years, and investors’ recency bias can make it easy to miss this bigger picture. More importantly, when you take out the Magnificent 7 stocks, international equities have outperformed U.S. stocks since the current rally began in late 2022. While U.S. growth stocks may still offer the possibility of compelling returns going forward, it may be imprudent to completely dismiss other opportunities that have yet to experience such stellar returns.

CONCLUSION

Many people use the beginning of a new year as a time to reflect on what occurred in the previous year, and to look forward while considering plans for the year to come. For investors, 2025 is dawning with an economy that, at a high level, seems to be in good shape. Inflation has cooled from its post-pandemic highs, unemployment remains low, and real economic growth has remained steady. Investors have been rewarded with two consecutive years of strong performance in U.S. equity markets, and bond yields are now elevated above where they have been for much of the last 15 years. Beginning a new year with a strong economy, and following two years of buoyant equity markets, may provide an opportunity for investors to reassess their portfolio and make any needed adjustments to their asset allocation. One such opportunity may be for investors to take profits from areas of the market that have outperformed, such as large-cap U.S. stocks, and use the proceeds to rebalance into areas like small-cap stocks or foreign stocks, particularly if these asset classes have dipped below their target allocations. This sort of strategic rebalancing will not only help you adhere to your strategic asset allocation, but doing so early in the year leaves plenty of time to utilize tax-loss selling and gifting strategies to offset some of the gains that may be accrued in this process. For bond investors, a steeper yield curve may present an opportunity. With a steeper yield curve, long-term rates are higher and short-term rates are lower. Investors may be able to take advantage of this by selling some of their short-term bonds, which have likely appreciated in value amid falling interest rates. They can then use the proceeds to buy higher-yielding, longer-term bonds. These longer-term bonds may be undervalued as their prices typically fall when interest rates rise.

A wonderful thing about investing is that each investor gets to set the rules for the investment “game” that they want to play. Developing individual goals and objectives for your investment portfolio determines how you will keep score and allows you to track your progress towards your goals along the way. A mistake that investors often make is not explicitly understanding the game they are playing, or simply failing to set the rules of the game, instead letting others decide for them what winning the game means. Or worse, they play the game blindly, never clear about their ultimate objective and unable to effectively assess their progress. And this is where your Corient Wealth Advisor can be of great assistance. By developing a comprehensive financial plan with your advisor, you are writing the rules of the game that you decide to play. It’s also much easier to play, and win, a game if you clearly understand the rules and how the game is scored. If you clearly understand what defines success for you, it becomes much easier to stay disciplined and tune out the noise that threatens to distract you from the task at hand, since much of the noise has little or no impact on the long-term results of your investment “game.”

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