January 2025
US Economy: Stable with stubborn inflation.
U.S. economic growth for 3rd quarter 2024 was revised upward to 3.1% annualized (from 2.8% ). On balance, consumer spending and the labor market continue to suggest economic stability: Retail sales (+0.7% Nov.) have accelerated while the unemployment rate (4.2% Dec.) ticked up just 0.1%. Meanwhile, core inflation (Core PCE +0.1% Nov.) has been “stickier,” which the Fed underscored in recent comments telegraphing fewer rate cuts in 2025.
US Stocks: Small-cap rally fizzles.
Equities finished December lower, on fewer projected interest rate cuts in 2025 and year-end profit taking. The only positive sectors were Communications (+3.6%), Consumer Discretionary (+2.4%) and IT (+1.2%) as the Mag 7 stocks returned to dominance. The small stock rebound, primarily in anticipation of more Fed rate cuts, fizzled as the Fed tempered expectations. Small-cap stocks have faced stiffer challenges from higher interest rates, inflation and a tight labor market post Covid.
Foreign Stocks: Politics sidelined.
Stocks in developed foreign markets fell in line with their U.S. counterparts. Still, European markets (-2.4%) largely shook off the collapse of France’s governing coalition as inflation there moderated further. Meanwhile, emerging markets continued to be driven by Asia, which has alternately lived and died on the economic outlook for China (+2.7%). The prospects for additional Chinese government stimulus boosted optimism again in December.
Fixed Income: Rate rebound 2025.
U.S. interest rates resumed rising, with the 10-year US Treasury yield hitting 4.6% at year-end. Inflation appears to be persisting modestly above the level typical for the past 20 years as Fed policy moderates. Pricing in that longer-term inflation, 10-year Treasuries yield 0.3% more than two-year Treasuries, the most in almost three years. Fiscal policy uncertainty including the likelihood of persistent federal budget skirmishes have added to upward pressure.
Real Assets: REITs swoon.
December wasn’t a great month for real assets, with few pockets of strength. The energy sector (+6.5%) buoyed commodities with the support of cold winter weather and geopolitical uncertainty. Rate-sensitive real assets, such as REITs (-6.9%) and infrastructure (-4.5%), performed poorly given the diminishing likelihood of substantially lower U.S. interest rates, and in the case of REITs in particular, simmering concerns about commercial real estate delinquencies and defaults.
Alternatives: Credit boost.
Hedge funds have performed in line with expectations and generally outperformed core fixed income. Credit-oriented investments have been excellent complements to hedge fund strategies, supported by an attractive lending environment and high yields: Many credit strategies returned more than 10% in 2024. Going forward, hedge funds and credit remain important portfolio diversifiers given that equity valuations seem stretched in many markets.
Source of data: Bloomberg
Equities Total Return
| DEC | 3 MOS | 1 YR | |
|---|---|---|---|
| U.S. Large Cap | (2.4%) | 2.4% | 25.0% |
| U.S. Small Cap | (8.3%) | 0.3% | 11.5% |
| U.S. Growth | 0.4% | 6.8% | 32.4% |
| U.S. Value | (6.9%) | (2.0%) | 14.0% |
| Int’l Developed | (2.3%) | (8.1%) | 3.8% |
| Emerging Markets | (0.1%) | (8.0%) | 7.5% |
Fixed Income Total Return
| DEC | 3 MOS | 1 YR | |
|---|---|---|---|
| Taxable | |||
| U.S. Agg. Bond | (1.6%) | (3.1%) | 1.3% |
| TIPS | (1.6%) | (2.9%) | 1.8% |
| U.S. High Yield | (0.4%) | 0.2% | 8.2% |
| Int’l Developed | (1.0%) | (1.0%) | (0.5%) |
| Emerging Markets | 0.8% | 1.7% | 7.5% |
| Tax-Exempt | |||
| Intermediate Munis | (0.7%) | (1.0%) | 1.4% |
| Munis Broad Mkt | (1.3%) | (1.1%) | 1.6% |
Non-Traditional Assets Total Return
| DEC | 3 MOS | 1 YR | |
|---|---|---|---|
| Commodities | 1.0% | (0.4%) | 5.4% |
| REITs | (8.0%) | (8.2%) | 4.9% |
| Infrastructure | (4.5%) | (2.5%) | 15.1% |
| Hedge Funds | |||
| Absolute Return | (0.0%) | 0.7% | 4.8% |
| Overall HF Market | (0.0%) | 0.1% | 5.2% |
| Managed Futures | 1.2% | 0.1% | 2.3% |
Economic Indicators
| DEC-24 | JUN-24 | DEC-23 | |
|---|---|---|---|
| Equity Volatility | 17.4 | 16.7 | 12.5 |
| Implied Inflation | 2.3% | 2.2% | 2.2% |
| Gold Spot $/OZ | $2624.5 | $2634.6 | $2063.0 |
| Oil ($/BBL) | $74.6 | $71.8 | $77.0 |
| U.S. Dollar Index | 128.7 | 122.1 | 120.2 |
Our Take
The final frame of 2024 ended up being gray toned for financial markets as Fed Chair Jerome Powell stated that any additional interest rate cuts in 2025 would be “approached cautiously,” sapping investor enthusiasm somewhat. Still, even with acknowledgement of the December pullback, financial market sentiment suggests investors are anticipating the most optimistic scenarios for 2025. While there is certainly data in support of a potentially rosy year ahead, there are several considerations that give us pause. In our Q1 Economic Commentary, due out mid-January, we focus on what could go right and wrong in 2025 as well as portfolio positioning. Here is what we are paying careful attention to in the near term:
- Sticky Inflation and Revised Rate Expectations: U.S. core consumer price inflation has been elevated above the Fed’s 2% target, with added potential pressure should the Trump administration pursue extreme tariff policies. We’ve already seen investors revise upward their longer-term inflation and interest rate expectations. A continued shift may catalyze swiftly rising long-term yields, dampening equity market valuations and creating turbulence for risk assets generally.
- AI Disappointments: Despite significant investment and enthusiasm surrounding AI’s transformative potential, the market has priced in rapid and substantial productivity gains. Should companies fail to deliver tangible financial benefits from AI infrastructure and software investments, investor sentiment could shift, derailing the broader bull market. A reassessment of AI-driven valuations could disproportionately impact the market-leading technology sector and/or the many sectors heavily reliant on technology.
- Trump Administration Policies. Expansionary measures such as targeted deregulation, infrastructure investment, and lower corporate taxes could provide meaningful tailwinds, particularly in regions with low baseline expectations. These fiscal initiatives would likely bolster corporate profits and economic momentum. With that said, Republicans’ inability to demonstrate alignment during the recent federal budget negotiations could be a harbinger of difficulties in pursuing their bold agenda this year.
- Financial Market Complacency. Financial markets look expensive in many areas and unanticipated developments could relieve equity markets of both enthusiasm and their lofty valuations in dramatic fashion. Such an unexpected shock to the system is always possible but is more likely during periods of higher uncertainty, where we find ourselves today. Some of our diversifying portfolio exposures are likely to hold up a bit better than others if we experience higher equity and/or bond market volatility.
