Printer Friendly PDF: 2024 Q4 Nvest Nsights Newsletter which also includes benchmarking and data on investments widely utilized in our current tactical strategies.
2024 Year in Review | Steve Henderly, CFA
There was no Santa Claus rally to conclude 2024. In fact, away from the largest technology names which permitted indexes like the size-weighted S&P500 to move upward, the average stock received a few lumps of coal in December. But even without a year-end rally, 2024 exceeded the expectations of most investors.
Twelve months ago, the S&P500 stood at a level of 4,770 and the average strategist’s target for 2024 was an advance of just 2%. A variety of concerns led the consensus to project a relatively mild return in the stock market as we entered 2024. Along with inflation and interest rate uncertainty, 40% of voters around the globe would choose new leadership; the most in history. Talk about uncertainty! Despite these concerns, the S&P500 leapt roughly 24% and logged 57 record highs to close at a level just shy of 6,000. How can the consensus so often miss the mark?
As we reflect
on 2024, what else stands out?
- Despite the Fed cutting overnight rates by 1%, interest rates for longer duration bonds and debts actually rose in 2024. After the fastest rate-hiking campaign in 40 years concluded in late-2023, the Fed remained on hold until September when it delivered a double-sized -50bps rate cut. It delivered two more quarter-point rate cuts in October and December. Businesses and consumers alike, hopeful that cuts would reduce the cost of borrowing, are yet to experience much benefit from the Fed’s recent cuts. Bonds forfeited a good portion of their total returns late in the year due to rates rising across all but the shortest maturities; and traditional cash-like investment yields (money market funds and CD rates) are becoming significantly less attractive.
- The 10 largest companies in the S&P500 now make up 40% of the index! This all-time high measure of concentration is primarily due to the continued and dramatic rise of the Mag-7 companies. Their performance positively distorted overall index performance for most of the last two years, providing more than 68% of the S&P500’s total return in both 2023 and 2024. Excluding the Mag-7, the S&P500 returned a more normal-looking 9.8% in 2024.
- Should the Mag-7 become the “Lag-7” or even the “Sag-7” due to their lofty valuations, it is increasingly possible they cause the cap-weighted index to appear worse than the average company stock.
- Nvidia stock, the darling of the Artificial Intelligence theme, leapt another +175% in 2024… this is on top of the nearly +240% return in 2023. The company’s stock presently trades at a price that is 53x earnings.
- Bitcoin managed to eclipse the level of $100k – a level that seemed impossible just a few years ago. We view bitcoin as a gauge of market speculation and liquidity – again a concerning anecdote that bullishness (animal spirits) may be a bit elevated.
- US mid-cap (advancing +14%), small-cap (+11%) and International (+4.5%) all detracted from overall portfolio performance relative to the mega-cap S&P500. Diversification and valuation-focused investing again seem of little benefit in 2024.
As we reflect on 2024, it would be easy to focus on how much stronger performance could be if one were to overweight the Mag-7 or even just mimic the “plain” S&P500. But for a second consecutive year, portfolios generated returns that are slightly better than what history suggests can be expected or similar to average over a long period of time. These returns are also well-ahead of the conservative estimates assumed within our LIVING LIFE financial planning projections for clients. The biggest success (what we and clients got right) last year is the active decision to remain focused on the long-term and stay invested despite much uncertainty, nervous market sentiment, and allure/comfort of cash continuing to yield near 5%. Remember, the market can and does often climb a wall of worry. Those staying true to their long-term growth objectives enjoyed far better total returns. That’s something we should be thankful for and heed whenever the feeling of uncertainty swells.
Entering 2025, the average strategist is calling for another +10% advance for the S&P500 and a year-end price target of 6,600. That is a more normal pace; we anticipate a more bumpy or volatile experience, especially when market sentiment seems so optimistic in the face of several crosscurrent questions at the start of the New Year.
In the words of Mark Twain, “It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.”
Green Great Dragons | Steve Henderly, CFA
How would you describe the picture to the right? Is it a ‘Green Great Dragon’ or a ‘Great Green Dragon’? In 2016, Matt Anderson, editor of BBC Culture and New York Times wrote a book and cited that native speakers of English subconsciously know adjectives should be in this order: opinion-size-age-shape-color-origin-material-purpose Noun. He suggests that if you do not follow that order you’ll sound silly or alter the meaning. ‘Green Great Dragon’ does not sound correct.
Perhaps that’s what’s so fascinating about Artificial Intelligence; computers are no longer just writing paragraphs, they’re crafting fluid and well-structured essays and assimilating data from a vast array of sources. (Credit to Strategas Research Partners for making this the subject of recent research on productivity).
For much of the last two years, companies most closely associated with the AI theme outperformed the broader market by exponential proportions. We often feel like a broken record, because client portfolios do own meaningful exposure to these exciting names, but we struggle to justify an overweight position due to the associated risk due to such lofty valuations. They are priced for perfection, as if nothing will ever go wrong and eye popping growth will carry indefinitely into the future. In fact, high valuations of the Mag-7 also distort the valuation of the S&P500 and make it hard to argue that stocks are not expensive. Valuation is the primary factor behind some strategists calling for uninspiring returns in the years ahead.
Domestic indexes with high concentrations to the Mag-7 and thus high overall valuations make it difficult to get excited for long-term investors—key is buying any investment at the right price. But at the same time, there is much hope for the economy entering 2025. Most believe that the odds of recession in the next 12-18 months are low. Others are optimistic that promises of corporate tax cuts, a reduction of government regulation, and low unemployment/high consumer confidence will propel the economy forward in the year ahead… call it “animal spirits”.
Another idea we find interesting is that the current decade could be similar to the “Roaring 20’s” from a century ago. Between 1920-29, the United States and Europe enjoyed an economic boom fueled by huge gains in productivity and optimism following the conclusion of WWI on the back of notable technological advancements including mass production of cars (Henry Ford’s assembly line revolutionized transportation and made it available to the middle class), and radio (increasing the flow and speed of information). Is Artificial Intelligence (AI) and faster-than-ever flow of data akin to the kind of technologies that boosted productivity and economic output a century ago? If so, they could provide the fuel for an economic and market surge that runs for a number of years. But to materialize, the focus must shift at some point to businesses “commercializing” the use of AI (examples like Deere and Caterpillar, using AI to automate farming/mining tasks).
Following the best two-year performance for the S&P500 since the 1990s, expectations for 2025 are high for a variety of reasons. But crosscurrents exist that could challenge the optimism at times, including early in the new year. For instance, the Fed adopted a more cautious and hesitant tone regarding additional rate cuts in December (after just commencing cuts 3 months ago). Investors are faced with how to balance optimism about productivity enhancing technologies like AI and animal spirits coincident with the recent election against the realities that tariffs, tax cuts, and immigration policy adjustments could renew upward pressure on prices (inflation). At the same time the new Department of Government Efficiency (DOGE) is challenging the status quo to trim fat from our government spending, but any cuts are certain to create big waves as they likely also affect many jobs. A key item the markets will monitor in the year ahead is the 10-yr US Treasury bond yield. Ten-year interest rates are back at 4.5%+, a level where market volatility surfaced during the past two years, and signaled the market was concerned about inflation and government debt levels. Is 2025 the year where the bond vigilantes make more noise, or “the bill for elevated government spending” comes due?
It appears an economic soft landing in the US is intact. Can we expect (hope for) a global economic upturn? With Europe and other central banks easing monetary policy and pursuing stimulus (China), it’s possible. A global upturn also supports the “Roaring 20s” scenario, but we suspect the path will be littered with numerous potholes and dips that create anxiety in 2025.
Big Questions For Investors in 2025:
- Can the Mag-7 continue to outperform, or do their lofty valuations position them to become the “Lag-7” moving forward?
It’s challenging to bet against the stocks with their projected growth rates more than 2x the remaining 493 companies in the S&P500. But any deterioration in the outlook (or results vs. expectations) could cause them to experience swift volatility, or at a minimum stall.
- Could 2025 be the year bonds fare better?
Following a historically challenging experience in 2022, an expected bounce in bond prices is yet to materialize. Yields on longer-dated maturities remain stubbornly high leaving most investors a
coupon-like return that is little better (or slightly softer) than the experience in money market funds. With yields on MMF/CDs now falling, it seems probable bond prices will bounce in 2025. Despite the anguish, bonds provide income and are an important asset class for controlling risk in portfolios.
- Will Trump policies, like tariffs, tax cuts, and deportations, help or hurt the economy?
Each of these policies can in theory raise prices for consumers and renew inflationary pressure. We suspect that most of the tough-talk on tariffs and immigration will be tempered and is part of negotiation tactics. Watch the yield on 10 year Treasuries for clues about the market’s views and expectation (a move materially above 4.5% probably signals rising concern about either inflation or deficit spending).
- Where will the Fed stop cutting rates this cycle? Or, how many more cuts might we see?
The market was again forced to quickly recalibrate the number of rate cuts in this cycle; it currently seems to be pricing in two additional cuts in 2025. If the economy softens, more cuts are possible; however, if inflation perks back up, then two cuts may be too many.
- Can mid- and smaller-cap companies outperform?
The WSJ recently highlighted 2024 as a year of extremes. US equities provided more than double the performance of international between 2000 and 2023 and delivered a further +29% of return compared with less than 5% for international fund managers. This is due both to the US dollar appreciation and the Magnificent 7, which now represents a third of the S&P500 (was 25% a year ago). The S&P600 (small companies) lag significantly. Small caps received a nice bump in November, only to see returns largely evaporate in December. But there’s hope! In the past (1970s Nifty Fifty, and 1990s Dot-Com bubble) when wide valuation differences existed, it was low-valuation stocks that provided strong performance vs. large-caps by significant margins. Long-term investors should remain opportunistic – acquire small caps while being cautious to avoid chasing crowded trades (Mag-7). De-regulation and lower tax rates in theory help more domestically oriented and small-cap sectors. Just one more item suggesting they’re due for their day in the sun.
Good Read for 2025 | Jordan Ranly, MBA
Happy New Year! As we enter 2025, I encourage you to take time to read “The Psychology of Money – Timeless lessons on wealth, greed, and happiness” by Morgan Housel. This book offers a neat perspective on human psychology and the impact on each individual’s perspective of wealth. One of my favorite quotes: “Use money to gain control over your time, because not having control of your time is such a powerful and universal drag on happiness.” Enjoy!
Markets Climb the Wall of Worry in 2024
