“The only constant in life is change.” – Heraclitus (535-475 BC)
“It is not the strongest of the species that survives, nor the most intelligent, but the one most adaptable to change.” – Leon C. Megginson (summarizing Darwin’s ideas)
The Year in Review: 2024’s Defining Themes
2024 will be remembered as the year the unexpected became reality, with geopolitical upheavals, dramatic policy reversals, and economic surprises reshaping the global landscape. Against this backdrop, markets delivered remarkable gains, underscoring the power of resilience and innovation. The U.S. economy continued to defy skeptics, buoyed by strong consumer spending, improving sentiment, and a robust labor market that added over 2 million net new jobs.
For the first time in years, central banks reversed course. Inflation, which had gripped the world’s economies post-pandemic, eased significantly, falling to below 3% in the United States. In response, the Federal Reserve, European Central Bank, and Bank of England cut interest rates in the latter half of the year. The Fed Funds rate ended the year at 4.25%-4.5%, a decline of 1% from its recent peak. While the reduction in rates was cheered by markets, the Fed’s outlook put a damper on enthusiasm as inflation remains a top concern for central banks.
Market Highlights
Investors enjoyed a banner year:
- Equities: The S&P 500 surged 25%, driven by a rally in mega-cap technology stocks fueled by exuberance over artificial intelligence. The 2023-2024 period marks the best 2-year performance for the S&P 500 since 1997-1998. Small-cap stocks also delivered a respectable 11.5% gain, while international equities rose 5.3% in USD terms (12.4% in local currencies, tempered by a stronger dollar).
- Bonds: Despite a decline in short-term interest rates, yields on long-term bonds increased, with the 10 Year Treasury rate increasing from 3.88% to 4.57%. The Bloomberg Aggregate Index, comprised of investment grade bonds, eked out a 1.25% return despite rising yields on longer-dated securities, with investors benefiting from the “positive carry” of higher yields and tightening of credit spreads.
- Commodities: The Bloomberg Commodity Index rose 5.4%, with gold emerging as a standout performer, climbing 26.8% amid geopolitical uncertainties.
Looking Ahead to 2025: Navigating Opportunities and Risks
A Wider Range of Outcomes
While the U.S. economy enters 2025 on strong footing, the range of potential outcomes remains wide. Advances in technology, deregulation, and proposed tax cuts could sustain upward momentum, fueling innovation, job creation, and corporate profits. Trade and immigration policies, on the other hand, could act as counterweights. Tariffs, if broadly implemented, risk fragmenting global trade and raising costs for consumers, while restrictive immigration policies could exacerbate labor shortages and wage inflation.
Republican control of Congress and the presidency means that President Trump has broad latitude to implement his agenda. Markets generally view his deregulatory stance, support for traditional energy, and corporate tax cuts favorably. However, potential inflationary pressures complicate the Federal Reserve’s decisions, as they balance the benefits of economic resilience against the risk of inflation.
Markets at a Crossroad
The lesson of 2023 is that markets often defy expectations. At the start of that year, many analysts predicted a downturn following aggressive Fed rate hikes and fears of a recession. Instead, markets staged a remarkable rally, driven by disinflation and technological innovation. Similarly, we must navigate today’s bullish sentiment with caution, as sentiment is a poor predictor of future results. Valuations remain a focal point as we consider the road ahead. Current valuations suggest future stock market returns may be modest.
Concentration risk is another concern. The top ten firms in the S&P 500 now account for 40% of the index’s market value, the highest level in history. While these firms have driven outsized gains, the current environment also highlights the importance of diversification to reduce reliance on a narrow set of companies. This dominance, largely driven by optimism surrounding artificial intelligence, leaves markets vulnerable to sharp corrections if sentiment shifts.
While markets present challenges such as elevated valuations and index concentration, they also include opportunities that very much excite us. In such an environment, diversification becomes paramount. While U.S. equities have led the charge, opportunities abound beyond the mega-cap tech giants:
- Small-Cap Resurgence: Smaller companies, trading at more reasonable valuations, could benefit from deregulation and lower corporate tax rates. Their domestic focus also insulates them from the adverse effects of tariffs. Their sheer number presents a larger opportunity set of ideas.
- International Opportunities: Non-U.S. markets, particularly in Europe and Asia, offer attractive entry points. Most would be surprised to hear European banks outperformed the Magnificent 7 this past year. European stocks trade at less than half the valuation of their American counterparts, while dividend yields and potential payout growth provide compelling opportunities. Structural reforms and favorable demographics position emerging markets as a long-term growth engine.
- Fixed Income: Investment-grade bonds, yielding over 5%, remain an appealing complement to equities. In addition to attractive yields, bonds may offer downside protection during recessionary periods, which tend to coincide with a flight to quality and reduced inflation expectations.
- Alternatives: Diversifying alternatives remain crucial by providing uncorrelated returns and enhancing risk-adjusted outcomes. Some of our alternative strategies also offer attractive tax benefits to taxable investors.
Closing Thoughts
As we close out 2024, we celebrate a year of growth and achievement while acknowledging the uncertainties and opportunities ahead. Your trust inspires us to continue providing the insights and strategies needed to navigate an ever-changing world. Thank you for allowing us to serve you on this journey, as we look forward to 2025 and beyond.
Razmig Der-Tavitian, CFA, CAIA
Chief Investment Officer & Managing Partner
SLK Private Wealth
