Hello and Happy New Year!
Market returns were very strong again last year. In fact, 2023 & 2024 were the first back-to-back years where the S&P 500 gained more than 20 percent in two and a half decades. GDP remained solidly positive throughout the year. In addition to general economic strength, the markets also received continued support from excitement about the potential for artificial intelligence. While these factors remain in place we do have some concern about increasing interest rates.
When the calendar turned last year, there was a great deal of hope about the potential for the Federal Reserve to significantly lower rates. While we were happy to see some coming rate relief, we thought that the expected number of rate cuts was far too high. This concern stemmed from two separate issues. The first is that inflation tends to come in multiple waves. While the first wave of inflation had clearly peaked, the “last mile” of inflation is generally the toughest to snuff out. The second concern was that there seemed to be a general acceptance that when the Fed cuts rates, rates go down. It is important to note that the Federal Reserve only controls the Fed Funds Rate, which is the rate at which commercial banks borrow and lend their excess reserves to each other overnight. While this is an important number, the US economy is more impacted by borrowing costs for things like cars and houses. These rates are determined by 5 and 10-year bond yields, which the Fed does not control.
The first Fed rate cut was on September 19th, when the committee lowered the overnight rate from 5.5% to 5.0%. The day before this meeting, the 10-Year Treasury (which is arguably the most important rate in the global economy) was 3.69%. After three rate cuts and several months, the 10-Year Treasury is now 4.68% and bumping up against 15-month highs. While we do not view interest rates as being high by historical standards, they are high relative to both hopes and expectations of early last year. As we look into 2025, our opinion is that, absent a recession, we are unlikely to see a significant further easing of interest rates. This doesn’t preclude asset prices from rising, but we think that it makes sense to lean into total return opportunities provided by dividends and investment income. Our primary job is to compound returns over time. When market index returns are lower, cash flow from dividends and income become increasingly important.
Plenty of things could benefit the markets during the coming year. GDP growth remains positive. There is the possibility of both tax cuts and deregulation, which tend to buoy markets. Additionally, betting against technological progress is rarely successful. But given the increase in asset prices since the onset of COVID, we think it is important to remember that market declines are common and that being prepared psychologically improves decision making during more difficult times.
For historical reference, market declines occur:
-5% or more about three times per year
-10% or more about once a year
-15% or more about once every two years
-20% or more about once every 3.5 years
To reiterate, even if we did think markets were going to decline, we wouldn’t meaningfully change client allocations. We also aren’t in the business of making prognostications about stock market moves. But there are a few things that make sense to us at the margin. The first is to make sure that our client’s asset allocations are aligned with their goals and objectives. This is not a one size fits all prescription. It requires a solid foundation in planning and executing to plan. Second, taking some profits is almost always a reasonable thing to consider. Third, short to medium term interest rates are now high enough that having a meaningful portion of investment assets in fixed income makes sense for most investors. We continue to be in a “ready position”, where we can take advantage of dislocations that will almost certainly occur. We wish you all the best in the new year and value the trust you have placed in us.
On a separate but important note, we wanted to give you a brief update on the continued investments we are making in personnel. Nancy Urbina has become fully integrated with Carl, Kimberly & Teresa and is helping provide exceptional service to all of our clients. We also made two additional hires last year: Thali Cobb & Alex Shanks. Thali is a recent graduate from Pitzer college, where he captained the Sagehens football team. Alex was a baseball player at Gonzaga, who worked at Deloitte while getting his CPA. We have gotten a new surge of energy from this next generation and are excited to see all that they can become.
Past performance is not indicative of future results and diversification does not ensure a profit or protect against loss. All investments carry some level of risk, including loss of principal. An investment cannot be made directly in an index.
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