01/30/2025
2024 Market Review
While 2024 delivered strong positive performance for the US stock market, a closer look reveals a more nuanced picture. The S&P 500 captured headlines with a 25% return, but it's important to remember that this represents a narrow slice of the market – large-cap US stocks.
A broader perspective reveals a more mixed bag. The Russell 2000, often seen as a barometer of the US economy, returned a more modest 12.9%. International stocks lagged further behind, with the MSCI All Country World Index (ex-US) delivering just 5.5%.
For balanced investors, the Morningstar Moderate Risk Index (60% stocks) returned 8.6%, while the Moderately Aggressive Index returned 10.7%. These indices likely capture the risk profile of most working-age adults.
Fixed income also faced headwinds, with the US Aggregate Bond Index yielding a mere 1.3% due to rising interest rates.
This variance in asset class returns highlights the importance of diversification and a thoughtful approach to portfolio construction. In this letter, we will explore the key market trends of 2024 and discuss how we are positioning portfolios for the year ahead.
Market Outlook for 2025: Momentum with Caution Amid Geopolitical Risks
President-elect Donald Trump campaigned on a platform of lower taxes and less-stringent regulations—seen as growth-positive—but also higher tariffs on imported goods and mass deportations of illegal immigrants—seen generally as stagflationary, at least initially (stagflation is a situation with high inflation, low economic growth and high unemployment). These crosscurrents and the uncertainties they are breeding make it difficult for stakeholders (both domestic and international) to plan for the future, potentially creating an environment of caution and concern across policy areas. Add to this a Federal Reserve operating in data-dependency mode, and we have a backdrop of reactionary market behavior and policy decisions.
The good news is that the past two decades have brought more sustainable and resilient growth in the domestic economy, and more self-sufficiency in terms of food and energy production, lessening the reliance on trade. This has led to higher returns on U.S. capital and in turn ample capital inflows alongside a strong U.S. dollar.
But there are other uncertainty wrinkles looking ahead, a key one being immigration policy. Regardless of your view about our immigration problem and appropriate solutions, unquestionably, slower immigration coupled with mass deportations will lead to a downshift in labor force growth and labor supply—also likely denting the economic demand side of that equation.
For now, the labor market remains healthy. The rise in the unemployment rate from 3.4% at the start of 2023 to its current 4.2% was largely a function of a significant increase in the labor force due to immigration—not due to layoffs. Assuming immigration falls and deportations pick up along side a slowing in the labor force, the downward pressure on wage growth could reverse. That, plus a lower sustainable rate of payroll growth could put the Federal Reserve in a bit of a pickle trying to adjust policy to that downshift, especially if inflation heats up.
On the pro-growth side of the ledger are tax-related proposals (including the extension of 2017's tax cuts and the possibility of a further corporate tax cut). That's in addition to pro-growth deregulation policies being proposed. There may be a timing issue given policies around tariffs and immigration can largely be done via executive order, while tax changes require congressional approval.
Transitioning to the stock market, we think overall that equities can do well from point A (the beginning of the year) to point B (the end of the year). However, the volatility backdrop is likely to be different from what investors got used to in 2024. This past year was defined by incredible sub-surface churn with minimal relative scarring at the index level: The maximum drawdown for the S&P 500 was -8.5%; the average member's maximum drawdown was -20%. The likelihood of a similar dynamic in 2025 is low, in our opinion.
One of the reasons for a step back in performance after such a strong year might be tied to valuation. Based on a five-year normalized price-to-earnings ratio,1 the S&P 500 is looking quite stretched, and in fact has only been more expensive in the late 1990s and 2021—of course, periods which preceded weakness in the market. However, we tend to view valuation as more an indicator of sentiment, and we believe the stretched valuation environment is a product of enthusiasm around equities, not necessarily in and of itself a risk to the market's near-term performance.
We continue to recommend staying up in quality, looking for stocks of companies with factors like improving profit, balance-sheet strength, ample interest coverage ratios (which measure a company's ability to pay interest on its debt) and healthy free cash flow.
Cautious Optimism in a Shifting and Uncertain Landscape
Consumer, business, and investor confidence surged following the 2024 election. Donald Trump’s second term is expected to bring new tax and tariff policies, creating potential economic friction. To put this optimism in context, according to Bank of American’s Fund Manger survey cash allocations fell to a RECORD low with equity allocation nearing 40%! In fact, not even 2001 or 2008 saw equity allocation at these levels. Such aggressive positioning should and has led to a near correction could continue throughout the early part of the year.
Additionally, geopolitical instability—ranging from global conflicts to trade disputes and rising tensions in key regions—could derail economic momentum. Equity investors and the Federal Reserve face little room for error, particularly if inflation rises and monetary policy options narrow.
Economic Growth to Continue, but at a Moderated Pace
The economy is expected to grow for a fifth consecutive year, fueled by a resilient consumer, steady job creation, fiscal spending through programs like the Inflation Reduction Act and the CHIPs Act, and investments in transformative sectors such as artificial intelligence. However, the pace of growth may moderate, particularly if geopolitical events disrupt global trade or supply chains.
Dialing Back Equity Market Expectations Amid Geopolitical Tensions
Following two consecutive years of over 20% gains for the S&P 500, tempered expectations are prudent. While market fundamentals remain solid—strong economic growth, positive earnings, and corporate activity—high valuations, potential complacency, and geopolitical risks could limit returns. Indeed Jamie Dimon, the CEO of JP Morgan Chase said, “World War III has already begun. You already have battles on the ground being coordinated in multiple countries,” at a event in Washington, DC on Oct. 24. A statement such as this from Dimon should not be taken lightly. With global instability threatening investor confidence, gold offers a stabilizing force, particularly in volatile equity markets.
Mid-Cap Stocks to Shine Despite External Risks
Mid-cap stocks, with their balanced exposure and predominantly domestic revenue focus, may outperform in 2025. They are anticipated to deliver 13% earnings growth, supported by attractive valuations. Their relative insulation from international trade disruptions or sanctions further enhances their appeal. Nonetheless, geopolitical events can ripple through all asset classes, making gold a valuable hedge even for mid-cap investors.
Key Sectors to Watch in an Unpredictable World
Investors should focus on technology, industrials, and health care, which align with long-term macro trends:
Technology: Innovation in AI and sustained corporate investment.
Energy: Dirty energy, coal and natural gas, may become back in vogue as governments look to solutions for energy shortages caused by the EV and AI revolutions. Pipeline stocks, which act as toll collector, seem particularly well positioned and offer the safey of dividends that range from 4% to 8%.
Industrials: Benefits from government spending, reshoring, AI-driven transformation, and infrastructure development.
Health Care: Attractive valuations and growing demand from demographic shifts.
While these sectors present opportunities, they are not immune to global instability.
Potential Black Swan - Debt Crisis
Rising interest costs on the federal debt have become a key concern as rates remain elevated. The Congressional Budget Office projects interest payments to approach $1.0 trillion in 2025. For context the DoD budget is $850 billion. Interest on debt fast becoming one the biggest expenses to the US Government. Compounding this challenge, a significant portion of U.S. Treasury debt—estimated at over $7 trillion—is set to mature in 2025. This necessitates substantial refinancing at prevailing rates, potentially amplifying debt-servicing costs and contributing to volatility in bond markets.
The Case for Hedging with Gold Amid Geopolitical Uncertainty
Geopolitical instability remains one of the most significant threats to market stability in 2025, with the potential to disrupt trade, supply chains, and investor confidence. Gold’s unique role as a safe-haven asset cannot be overstated in this environment. Its ability to preserve wealth during periods of inflation, economic uncertainty, and global turmoil makes it an indispensable part of a well-rounded portfolio.
By balancing optimism with prudent risk management—including a strategic allocation to gold—investors can better weather the challenges posed by 2025’s complex and unpredictable landscape.
