DSWM Quarterly: Q4 2024

As was the case at the beginning of last year, 2025 starts with investors celebrating another strong year of returns across most of the market, but cautiously optimistic for the year to come. The caution is for good reason, the global economy shows signs of both resiliency and challenges, impacted by uncertain interest rate paths, ongoing geopolitical tensions, and shifting political regimes in many countries. At the same time, when investors look back at 2024, the year began with every market participant looking for a reason why the market was going to give back the strong returns of the prior year. Those that were not swayed by the “bear market is coming” pundits and stayed invested throughout 2024, were rewarded as nearly all areas of the markets were positive, highlighted by the U.S. large cap equity market delivering over 20% for the year.  

Central banks across major economies have adopted similar approaches to monetary policy. As most central banks have shifted to an easing monetary policy stance with rate cuts. In the United States, the Federal Reserve began cutting rates in September with a 50bps cut and subsequent 25bps cuts in November and December. However, in mid-December, comments from Federal Reserve Chair Jerome Powell roiled markets as he raised the Fed’s inflation outlook and signaled fewer expected rate cuts in 2025. The shift in Fed sentiment rattled investors who were expecting continued interest rate relief in early 2025. The result was that the S&P 500® dropped by over 3%, erasing a large portion of the gains for the 4th quarter. 

For the year, U.S. large cap equities continued to be in the driver’s seat of portfolio returns, fueled by a strong U.S. consumer that kept corporate profits healthy across most sectors. At the helm of large cap U.S. equities returns were once again technology companies, in particular the “Magnificent 7” (Alphabet, Amazon, Apple, Meta Platforms, Microsoft, NVIDIA and Tesla). The optimism for the potential impact of technological advancements in artificial intelligence (AI) continues to push the value of these companies higher. The significance of these large technology companies to market returns in 2024 is exemplified by the 2 to 1 outperformance of large cap U.S. growth equities to value for the year. An outlook shared by some analysts for 2025, is that U.S. equity returns will broaden out beyond the tech companies. The basis of this theory is that the uses for the new AI technologies will become clearer for companies outside of the tech sector. Along with already strong earnings amongst most U.S. companies, implementation of AI technology will begin to add to returns for areas of the U.S. market that have posted far more conservative returns in recent years, such as value and small cap stocks. Another widely held thought amongst analysts for 2025 is although they see potential for positive U.S. equity returns, there is also potential for heightened periods of volatility. This should not be a surprise, since we have a new administration taking office which will begin to work on implementing their policy agenda and trying to unwind some of the policies implemented by the outgoing administration. Even when a political party has a majority in the House and the Senate, along with the Presidency (it should be noted, this is only the 9th unified government since 1975 for either party), we all know that the process of enacting policies in Washington is a fluid situation and many times a lengthy one. The thought is the market could experience some periods of heightened volatility in the year ahead, as it tries to digest a constant flow of news from Washington.

International markets continue to trail the U.S., broadly delivering positive results for the year, but with inconsistent returns quarter to quarter for 2024. With inflation seemingly under control, the European Central Bank, like the U.S., embarked on a monetary policy easing cycle. Although many economies in the Eurozone are vulnerable to recession risk, the easing in monetary policy is expected to keep growth positive for the year to come. In Japan, the Bank of Japan’s campaign of reinflation, continues to be successful with wage increases and additional steps towards monetary policy normalization. If rising wages can continue to keep pace with higher prices, then there is optimism that the Japanese economy can maintain at least it’s current rate of growth into 2025. Shifting to emerging markets, the Chinese economy continues to be in a precarious situation with the unraveling property crisis they are facing. The uncertainty surrounding the additional need and availability of government stimulus makes the 2025 outlook for the Chinese economy unclear. Outside of China, other emerging markets have a brighter outlook, as cycles of interest-rate cuts from U.S. Federal Reserve have typically served as a strong tailwind for emerging market economies. This is caused by expectations of higher demand for natural resources (most EM countries depend on natural resource exports) to fuel the growth caused by lower rates. Also, much of the debt issued by emerging market countries is linked to U.S. rates, so lower U.S. rates can lead to lower interest expense for some emerging market economies. 

After a strong 3rd quarter for bonds, bonds of all types struggled during the 4th quarter, with everything from treasuries to the high yield sector seeing prices pushed lower.  The major bond selloff began following the outcome of the U.S. presidential election, which led to bond yields rising (and bond prices going down) as the bond markets began pricing in the potential for policies aimed at economic growth that might come at the cost of inflationary pressures and deficit spending. The longer end of the yield curve (bonds with longer maturities) sustained the biggest losses, as exemplified by the 30-year treasury bond index pulling back by nearly 8% for the quarter. The short end of the yield curve fared much better for the quarter, posting less than a 1% pullback. In our portfolios, we have been intentionally slow to extend the maturity of our fixed income holdings. One of our concerns with extending the maturities too soon was as the yield curve shifts to a more normal shape (upward sloping, with short-term yields lower than long-term yields), our expectation was for long-term yields to rise. This results in prices going down and a negative impact on returns. 

Back in January 2024, when we reflected on 2023 in our commentary, we referred to the strong market returns of 2023 as a “pleasant surprise.” Now that 2024 has concluded and from a market returns perspective the year had many similarities to 2023, can we again call it a “pleasant surprise”? We can all agree that a year in which U.S. large cap indices are up over 20% for the year is at the very least “pleasant”, but was it a surprise, we believe the answer is “of course it was.” We have always held that no one can predict the closing level a day from now, any more than they can return 5 years from now, thus the path of the market is always a surprise. The dramatic difference between sentiment to start the year and the market outcome for 2024 is not a unique occurrence. It happens all too often, investors become convicted of an upcoming market move, only for the exact opposite to happen. It does not mean they read the data wrong or they are bad investors, rather they set expectations for the future. We believe that predicting the future is impossible, so why do so many investors elect to try to do it with their money? A better mindset to approach long-term investing can be summed up by an excerpt from a quote in Oscar Wilde’s play An Ideal Husband, “expect the unexpected.”  We do not know if the next surprise is going to be pleasant, unpleasant, or something in between, so we need to be prepared for the “unexpected.”  At Droms Strauss we prepare your portfolio for the “unexpected” through diversified portfolio construction, monitoring, and disciplined long-term investing so the focus is maintained on your long-term goals and not short-term “expectations” for the market. 

As always, thank you for entrusting us with your portfolios. We wish you a healthy and happy New Year!

Droms Strauss Wealth Management

www.droms-strauss.com

(314) 862-9100

For information purposes only. Opinions expressed herein are solely those of Droms Strauss Wealth Management, unless otherwise specifically cited.  Material presented is believed to be from reliable sources, but no representations are made by our firm as to another parties' informational accuracy or completeness.  All information or ideas provided should be discussed in detail with an advisor, accountant, or legal counsel prior to implementation. Past performance may not be indicative of future results. Indexes are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns.