2024 wrapped up another green year for markets, with the S&P 500 price index returning 23.3% (yCharts). Strength was broader versus 2023, with the consumer discretionary, financial, technology, communications, and utilities sectors all posting +20% returns for the year as well. Conversely, cooling pricing pressures weighed on energy and materials stocks with both sectors returning near zero (yCharts).
International markets had been strong too until Trump’s election victory and his promise to implement tariffs on imported goods. Tighter monetary policy in Japan and political turmoil in France also dimmed the performance of overseas markets. Bonds had performed quite well through the summer but gave back much of their gains through year-end as the prospect of big rate cuts in 2025 and 2026 decreased. The Barclays US Aggregate Bond Index, which is a widely used benchmark for bond performance, edged higher by 1.25% in 2024 (yCharts).
The Fed Plays It Safe and Anticipates Fewer Rate Cuts in 2025
Jerome Powell, who chairs the Federal Reserve, remarked in August that “the time has come for policy to adjust. (CNBC)” He was referring to winding down the restrictive monetary policy measures (higher rates, quantitative tightening) put in place over the last three years to combat inflation. The policy pivot was accompanied by cuts to the benchmark Federal Funds Rate which included a 0.50% reduction in October, a 0.25% cut in November, and another 0.25% decrease in December (Federal Reserve).
The December rate cut was accompanied by a second, hawkish shift in tone, with Federal Reserve members changing their rate cut forecasts from 1.00% of cuts in 2025 to just 0.50%. These forecasts were accompanied by projections indicating zero additional progress in bringing inflation down to the Fed’s 2% target in 2025 (Federal Reserve).
Source: Federal Reserve
What happened between October and December? Inflation ticked slightly higher, led by shelter costs, general services, and beef/egg prices (Bureau of Labor Statistics). The labor market weakened slightly, with the unemployment rate ticking higher and initial jobless claims remaining flat (Bureau of Labor Statistics, U.S. Employment & Training Administration). None of these data points would suggest an imminent resurgence in inflation.
But wait – the election happened, and the winning party has proposed some very inflationary (e.g. tariffs) and stimulative (tax cuts and fewer regulations) policies. If the Democrats had won, the stimulative effects of social spending would have been partially offset by higher taxes on the wealthy and corporations. A divided government, likely unable to pass any substantial legislation, would have been neither stimulative nor inflationary.
In our opinion, the Fed is playing it safe and waiting to see what the Republicans are going to do. As of now, investors aren’t a fan of the policy pivot, with stocks lagging into year-end. Long-term interest rates remain near 17-year highs on an inflation-adjusted basis, indicating restrictive lending conditions for longer-term loans such as mortgages and corporate bonds (Federal Reserve Bank of Cleveland). Short-term interest rates are falling thanks to recent rate cuts but remain in clearly restrictive territory. These conditions could potentially temper the effect of any Republican stimulus measures in the new year.
Source: Federal Reserve Bank of Cleveland
Beyond the Fed: The Big Tech, Magnificent 7 Shines Again
Stock market leadership during the first half of the year was dominated by the Magnificent 7 mega-cap technology stocks (Apple, Alphabet, Microsoft, Tesla, NVIDIA, META, Amazon), with AI darling NVIDIA at the helm and nearly tripling during the first six months of the year (yCharts). Big banks almost caught up to big tech in the second half of the year, but most other sectors and international markets lagged.
We view technology leadership through a lens of opportunity costs. Stocks are valued versus the next best thing to invest in – usually bonds, which are less risky. When interest rates on bonds increase, it makes stocks less attractive. In other words, a stock with an 8% profit margin will attract many more buyers if bonds are yielding 2% versus 7%. It’s all about “discount rates” and opportunity costs.
Big tech, and namely the Magnificent 7, has combated higher discount rates with increased earnings and profitability. If a company can grow its earnings and increase its profit margins beyond the increasing cost of borrowing, it should be rewarded. That’s at least one takeaway one can gather from academic literature pieces such as “The Other Side of Value: The Gross Profitability Premium” by Novy-Marx and “Buffett’s Alpha.” To wit, the chart below shows the tech-heavy S&P 500 Growth Index’s forward profit margins versus the margins of the S&P 500 Value Index. It’s clear where margins are expanding versus remaining constant.
Source: Yardeni Research
Selecting stocks based on their profitability is called “quality factor” investing (Kitces). We use profit margins as a screen for our individual stock strategies and invest in a fund with the symbol QUAL that scans for highly profitable stocks in our ETF portfolios. It’s a strategy the research above indicates can outperform over the long run. However, like any investing style, performance is cyclical, and “quality” stocks can underperform for long periods of time, usually due to eventual overcrowding and overvaluation. That’s why we choose to diversify our various factor exposure to include other stocks with what we believe are winning characteristics, such as a history of dividend growth, positive momentum, attractive valuations, and low volatilities. We believe that by diversifying between factors and sectors, we can achieve greater risk-adjusted returns and lower volatility versus putting all our eggs in one investing “style basket.”
Final Thoughts – Remember That Stocks Can Be Volatile
2024 was not only a strong year for stock returns but also for the lack of volatility. Despite fits and starts with global inflationary pressures, uncertainty surrounding the election, and ongoing conflicts in the Middle East, market pullbacks have been both shallow and short-lived. Only two marginally noteworthy retracements come to mind this year – a two-week 5.5% hiccup in S&P 500 in April and an 8.5% drop in July.
Markets also weakened through mid-December and year-end, although the peak-to-trough drop thus far in the S&P 500 has been less than 5%. We are closely monitoring key levels in the major indexes as well as various momentum indicators, as our analysis suggests this downswing may have more room to run in the new year. Regardless of what retracement does or does not develop, our proprietary supply chain and leading economic indices continue to reflect a healthy market and economy. Therefore, any bout of winter volatility, if one develops, should be viewed as a short-term and normal pullback in an ongoing bull market, and thus a buying opportunity.
Whatever’s to come in 2025, we will be prepared for it with our evidence-based research methodologies and investment strategies. We wish you and your families a healthy and prosperous new year and look forward to talking to you soon.
Year-End Commentary: A Green 2024 for Markets and What’s Next in 2025
2024 wrapped up another green year for markets, with the S&P 500 price index returning 23.3% (yCharts). Strength was broader versus 2023, with the consumer discretionary, financial, technology, communications, and utilities sectors all posting +20% returns for the year as well. Conversely, cooling pricing pressures weighed on energy and materials stocks with both sectors returning near zero (yCharts).
International markets had been strong too until Trump’s election victory and his promise to implement tariffs on imported goods. Tighter monetary policy in Japan and political turmoil in France also dimmed the performance of overseas markets. Bonds had performed quite well through the summer but gave back much of their gains through year-end as the prospect of big rate cuts in 2025 and 2026 decreased. The Barclays US Aggregate Bond Index, which is a widely used benchmark for bond performance, edged higher by 1.25% in 2024 (yCharts).
The Fed Plays It Safe and Anticipates Fewer Rate Cuts in 2025
Jerome Powell, who chairs the Federal Reserve, remarked in August that “the time has come for policy to adjust. (CNBC)” He was referring to winding down the restrictive monetary policy measures (higher rates, quantitative tightening) put in place over the last three years to combat inflation. The policy pivot was accompanied by cuts to the benchmark Federal Funds Rate which included a 0.50% reduction in October, a 0.25% cut in November, and another 0.25% decrease in December (Federal Reserve).
The December rate cut was accompanied by a second, hawkish shift in tone, with Federal Reserve members changing their rate cut forecasts from 1.00% of cuts in 2025 to just 0.50%. These forecasts were accompanied by projections indicating zero additional progress in bringing inflation down to the Fed’s 2% target in 2025 (Federal Reserve).
Source: Federal Reserve
What happened between October and December? Inflation ticked slightly higher, led by shelter costs, general services, and beef/egg prices (Bureau of Labor Statistics). The labor market weakened slightly, with the unemployment rate ticking higher and initial jobless claims remaining flat (Bureau of Labor Statistics, U.S. Employment & Training Administration). None of these data points would suggest an imminent resurgence in inflation.
But wait – the election happened, and the winning party has proposed some very inflationary (e.g. tariffs) and stimulative (tax cuts and fewer regulations) policies. If the Democrats had won, the stimulative effects of social spending would have been partially offset by higher taxes on the wealthy and corporations. A divided government, likely unable to pass any substantial legislation, would have been neither stimulative nor inflationary.
In our opinion, the Fed is playing it safe and waiting to see what the Republicans are going to do. As of now, investors aren’t a fan of the policy pivot, with stocks lagging into year-end. Long-term interest rates remain near 17-year highs on an inflation-adjusted basis, indicating restrictive lending conditions for longer-term loans such as mortgages and corporate bonds (Federal Reserve Bank of Cleveland). Short-term interest rates are falling thanks to recent rate cuts but remain in clearly restrictive territory. These conditions could potentially temper the effect of any Republican stimulus measures in the new year.
Source: Federal Reserve Bank of Cleveland
Beyond the Fed: The Big Tech, Magnificent 7 Shines Again
Stock market leadership during the first half of the year was dominated by the Magnificent 7 mega-cap technology stocks (Apple, Alphabet, Microsoft, Tesla, NVIDIA, META, Amazon), with AI darling NVIDIA at the helm and nearly tripling during the first six months of the year (yCharts). Big banks almost caught up to big tech in the second half of the year, but most other sectors and international markets lagged.
We view technology leadership through a lens of opportunity costs. Stocks are valued versus the next best thing to invest in – usually bonds, which are less risky. When interest rates on bonds increase, it makes stocks less attractive. In other words, a stock with an 8% profit margin will attract many more buyers if bonds are yielding 2% versus 7%. It’s all about “discount rates” and opportunity costs.
Big tech, and namely the Magnificent 7, has combated higher discount rates with increased earnings and profitability. If a company can grow its earnings and increase its profit margins beyond the increasing cost of borrowing, it should be rewarded. That’s at least one takeaway one can gather from academic literature pieces such as “The Other Side of Value: The Gross Profitability Premium” by Novy-Marx and “Buffett’s Alpha.” To wit, the chart below shows the tech-heavy S&P 500 Growth Index’s forward profit margins versus the margins of the S&P 500 Value Index. It’s clear where margins are expanding versus remaining constant.
Source: Yardeni Research
Selecting stocks based on their profitability is called “quality factor” investing (Kitces). We use profit margins as a screen for our individual stock strategies and invest in a fund with the symbol QUAL that scans for highly profitable stocks in our ETF portfolios. It’s a strategy the research above indicates can outperform over the long run. However, like any investing style, performance is cyclical, and “quality” stocks can underperform for long periods of time, usually due to eventual overcrowding and overvaluation. That’s why we choose to diversify our various factor exposure to include other stocks with what we believe are winning characteristics, such as a history of dividend growth, positive momentum, attractive valuations, and low volatilities. We believe that by diversifying between factors and sectors, we can achieve greater risk-adjusted returns and lower volatility versus putting all our eggs in one investing “style basket.”
Final Thoughts – Remember That Stocks Can Be Volatile
2024 was not only a strong year for stock returns but also for the lack of volatility. Despite fits and starts with global inflationary pressures, uncertainty surrounding the election, and ongoing conflicts in the Middle East, market pullbacks have been both shallow and short-lived. Only two marginally noteworthy retracements come to mind this year – a two-week 5.5% hiccup in S&P 500 in April and an 8.5% drop in July.
Markets also weakened through mid-December and year-end, although the peak-to-trough drop thus far in the S&P 500 has been less than 5%. We are closely monitoring key levels in the major indexes as well as various momentum indicators, as our analysis suggests this downswing may have more room to run in the new year. Regardless of what retracement does or does not develop, our proprietary supply chain and leading economic indices continue to reflect a healthy market and economy. Therefore, any bout of winter volatility, if one develops, should be viewed as a short-term and normal pullback in an ongoing bull market, and thus a buying opportunity.
Whatever’s to come in 2025, we will be prepared for it with our evidence-based research methodologies and investment strategies. We wish you and your families a healthy and prosperous new year and look forward to talking to you soon.
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