Posted: 1-8-25 | Innovia Wealth
Highlights:
- Strong equity returns in 2024
- Below average bond returns
- Strong U.S. economy
- The Federal Reserve cut rates for the first time in four years.
- 2024 ended with erasing uncertainty around election results
- 2025 looks good for stocks, okay for bonds, and most interesting for private investments.
| Asset Class | Total Returns |
| Large companies (S&P 500) | 25.0% |
| Big technology businesses (Nasdaq 100) | 25.9% |
| Small companies (Russell 2000) | 11.5% |
| Foreign stocks (ACWI ex US) | 6.1% |
| Bonds (Bloomberg US Aggregate) | 1.3% |
Markets
Stocks did very well in 2024, with large companies (purple) and technology (orange) leading the pack. Enthusiasm for artificial intelligence continues to thrill investors, although questions about corporate spending plans over the summer dampened technology share gains. Smaller businesses (blue) did well once it was clear the Federal Reserve would finally cut interest rates last summer, and election results made mergers and acquisitions more likely to be seen through than under the prior administration. International stocks (green) did not do as well, especially late in the year, as the U.S. dollar was strong on higher interest rates and an increasing expectation of tariffs. Earnings drive equity returns more than anything else, and solid profit growth from large tech companies fueled returns in 2024 more than anything else (see chart below).
Source: Cornerstone Portfolio Research, https://www.spglobal.com/spdji/en/documents/additional-material/sp-500-eps-est.xlsx
Bonds posted below average performance (fuchsia) as investors expected six to seven interest rate cuts in 2024 and got only four (blue line below). Fixed income returns suffered as long-term interest rates finished higher (4.6%) than they started (3.8%) the year; bond prices go down as rates go up.
Economy
Inflation trended down throughout the year (purple line above), although not as much as investors had hoped. It is hard to reduce inflation once it reaches higher levels because the impacts ripple across the economy in rent step-ups, wage negotiations, contract adjustments, etc. Inflation has decreased but not below the Federal Reserve’s 2% aimpoint. That did not stop the Federal Open Market Committee from cutting interest rates by 1% over the year (blue line above). The Federal Reserve is attempting to keep employment, inflation and economic growth in balance. So far, its efforts seem to be working as unemployment increased only 0.7% over the last 2 years, jobless claims remain below 300,000 per month, and over 148,000 new jobs were created on average each month (first chart below). Consumer spending remained robust as well (second chart below). People at the lower end of the income spectrum are not doing well judging by credit card and auto loan delinquencies, but consumers on average are spending and travelling more than ever.
Geopolitics
It seems hard to recall, but 2024 started with a budget battle in Congress. A temporary resolution early in the year kicked the can down the road and seemed to assuage investors for the time being. Other geopolitical risks included the on-going war between Russia and Ukraine, China continuing to press its claims over Taiwan, Israel making significant progress against Hamas and Hezbollah, and the Syrian regime collapsing after years of civil war. Fortunately, none of these conflicts spiraled out of control despite meaningful risks of doing so.
Late in 2024, the U.S. elections dominated headlines. Trump won the Republican nomination, Biden pulled out of the race after a weak debate showing, and Harris was hastily put in his place. There were material concerns the election would be close enough to be contested, wherein election uncertainty would fuel concerns for markets. That did not turn out to be the case as Republicans won the Presidency and thin majorities in the House and Senate. Without a doubt, a smooth transition of power is what financial markets prefer.
Looking ahead
2025 will begin with a keen focus on the incoming administration and a new Congress. Executive appointments and initiatives like budget cuts, tariffs, and immigration are sure to make headlines. Leaders in Europe and Asia, Canada, and Mexico are adjusting their playbooks to the meaningful U.S. leadership change. How these countries react could determine political, economic, and market outcomes. We do not claim to know what will happen—there are simply too many variables and unpredictable players involved—but we are considering how to position portfolios and adjust exposures depending on what opportunities and risks present themselves.
Wall Street analysts expect another strong year for stocks with forecasts of 9-17% equity returns and 15% earnings growth for the S&P 500. Valuations are historically high but are a lousy gauge of short-term returns. That being said, valuations tend to be a more accurate predictor of returns over five-to-ten-year periods. This makes us cautiously optimistic about equity returns in 2025 with a preference for parts of the market that are not as fully valued: smaller companies, low price-to-fundamental “value” companies, and international businesses.
Fixed income returns are likely to be historically average with good yields and low defaults. Parts of the bond market, especially mortgage-backed securities and select corporate bonds, offer higher returns with low levels of risk. For taxable accounts, short- and long-dated municipal issues look like the best options after accounting for their taxable equivalent yield.
Private market investments tend to offer lower reported volatility along with the possibility for higher returns, which is why we focus a fair amount of time in this area. We hope to offer some intriguing new opportunities over the year both in a fund form as well as on an individual basis. We look forward to discussing these with you. Watch future letters for details.