For the quarter ending December 31st, 2024.
Let's face it, the November election overshadowed just about everything else this past quarter. Not even two rate cuts by the FOMC were enough to stop the bleeding in the bond market. If you ponder this for a moment, you realize the significance of bonds losing value as the Fed was lowering the cost of capital. When was the last time that occurred?
So back to the initial statement: the convincing Trump victory immediately created the following narrative: tariffs will increase, as should economic activity (the term 'animal spirits' is once again in vogue); wages - especially among lower-level workers - will increase with a reduced workforce thanks to deportations; and taxes will be lowered, which may increase the federal deficit and debt. All of this should result in an increase in interest rates. Now, whether all, some, or none of this actually comes to fruition remains to be seen. But at the end of the day, this narrative put the FOMC rate cuts back to page-five reading.
Yes, the bond market took a beating over the past few months while domestic stocks continued to head northward in the face of rising skepticism. Nothing new here, but technology issues trounced all the other sectors as the U.S. trounced just about every other country. In other words, it paid to stay home and go big in 2024.
As we look ahead to 2025, Washington, D.C., will continue to grab the headlines and, like it or not, probably provide direction to the capital markets. The Fed will try to save face, but let's not kid ourselves: who can compete with Donald Trump for headlines, airtime, and social media feeds? And don't forget to look out for geopolitical surprises. After all, Putin, Xi, and their North Korean little (big) boy all want some face time too. Welcome to 2025.
Highlights
Final reading of year-over-year third quarter GDP at 3.1%
FOMC cut rates two times in the 4th quarter (three for the year), baseline rate stands at 4.50%
Unemployment at 4.2% while inflation at 2.7% - both trending (slightly) upward
Domestic stocks increased by 2.6% in the 4th quarter and 23.8% for the year
Technology sector was the strongest performer for the quarter and year, healthcare the worst
Foreign stocks, both DM and EM, continue to drastically trail the U.S.
10-year Treasury yield ended 2024 at 4.58%, from 3.88% at year-end 2023
Domestic bond market was down -3.1% in the 4th quarter, bringing 2024 to a 1.3% gain
For the quarter and year, treasuries underperformed high-quality corporate, which underperformed high-yield
World equity real estate lost -9.5% for the quarter, primarily due to weak foreign stock markets
Global infrastructure was down -2.9% for the quarter, though increased 11% for the year
Hedge funds were basically flat for the quarter and up 6% - 8% in 2024
S&P 500 Valuation Measures
Much has been discussed and written about the frothy valuation measures of the domestic stock market. Well, here is the data from which to draw your own conclusions. The most often used measurement, Forward P/E, stands at 21.5x, which is 1.4x higher than the long-term average of 16.9x.
Other measures, such as Shiller's P/E, Dividend Yield, P/CF, and on are anywhere from 1.5x to 2.2x of their long-term averages. Most discerning, only two times since 1994 has the Forward P/E been higher than today. And in both cases, the stock market experienced significant corrections. It could be time to not only buckle your seatbelts but to tighten them as well.
P/E Ratios and Equity Returns
From the previous page we know the market is expensive, based on a variety of accepted measurements. This chart provides a glimpse as to what an expensive market can deliver on a go-forward basis. For example, we know there is a correlation that over the following year, higher P/E markets tend to provide lower returns, though this rule of thumb has been violated often since 1999.
More telling is the subsequent five-year returns. Here you can see a definite correlation between the market valuation and future performance. On that score, with today's P/E at 21.5x, the odds of outsized stock returns are significantly reduced.
S&P 500 Index: Index Concentration and Valuations
If you're looking to dump all your domestic stocks after reading the previous two pages, hold on for just a minute, as there is always another side to the story. As can be seen here, much of today's market frothiness is due to the valuations of the top 10 names with a P/E of 29.8x. Yes, we are talking about Google, Microsoft, Amazon, etc. Remove these companies from the equation, and the market P/E is a much tamer 18.2x. Still pricey given their long-term average is 15.7x, but not as high. Finally, even with remarkably high P/E ratios, the top names have outstanding profit margins, too. So unlike in 1999, for example, they are making money for investors as well.
Global Trade Patterns
Starting in 2018, the long decline in China-directed tariffs reversed. This was a significant turn of events and brings us to the present day where the average tariff on goods imported from China is nearing 11%. This represents a fourfold increase over six years and threatens to go higher.
While retaliatory measures are certain, the U.S. is in a better position given we are the number one export market for Chinese goods and, unlike China, we also are not an export-dependent economy - thank you, dear consumer. Also, we now import more from Mexico and the Euro Area while multiple Asian economy imports are growing as well. Bottom line, China has more to lose than the U.S.
U.S. Real Estate: Vacancy Rates and NOI Growth
The effects of the Covid induced lockdowns have been dramatic - socially, economically, health wise and on. One industry that has seen more than its share of turmoil has been commercial real estate (CRE). The hardest hit has been office properties as their vacancy rate went from under 10% to nearly 15%. Retail and apartments are back close to their long-term averages while industrial property vacancies fell below 2% in 2023 and are now trending back towards their long-term average as well. Yes, covid and the resultant Amazon effect have had profound consequences on commercial real estate. We are now challenged with the effects of Al on CRE. Data centers anyone?
Performance - Equities
Not to brag, but we did mention in the previous quarterly update that the emerging market rally was primarily due to China's stimulus measures, which were not sustainable. Fast forward a few months and China is down nearly 8% while emerging markets as a whole are down the same and developed markets -8.1%.
Yes, it remains all about the U.S. as stocks here at home rose 2.6% in the fourth quarter, bringing 2024 to an outstanding 23.8% return. Over every period going back 15 years, the performance disparity is dramatic. But don't get too excited as most of this outperformance is due to a handful of giant tech issues. Sustainability may be in question here as well.
Performance - Fixed-Income
Well, so much for FOMC rate cuts spurring a bond rally. And even though two of the year's three cuts came in the fourth quarter, bonds were still down -3.1%. For the year, bonds squeaked out a 1.3% gain, though in real terms it was negative given inflation in 2024 through November stood at 2.4%.
Ouch. Overall, it continued to pay off by keeping your duration short in 2024 as 1-3 year issues were up 4.1% for the year while long-term bonds were down -6.5%. Those that invest in EM debt also paid a steep price in the fourth quarter as this asset class lost a whopping -7.8%. The best performing were DM bonds abroad, rising 70 bps for the quarter and 5.0% for the year.
Performance - Alternatives
2024 represented another year that, in general, alternatives outperformed the bond market but trailed domestic stocks. Yes, all the primary asset classes underperformed the U.S. stock market, but it's still a bit frustrating when diversification away from domestic stocks translates into reduced returns.
The good news is, except for equity global real estate, the alternative assets listed below provided a real return net of inflation. Hedge fund indices returned around 6% - 8% for the year, about the same as commodities. The clear winner was global infrastructure with an 11% gain. Note: these indices represent public alternative assets, not private market investing.
Comments