Executive Summary
The fourth quarter of 2024 was mixed for stocks, which peaked in the U.S. on December 16th on a post-election relief rally; and then declined during the last two weeks of the year. At its December 18th meeting, the Fed cut by 0.25% to follow the first Fed cut, which was 0.5% this past September. The elephant in the room is inflation, which remains stubborn; and longer-term interest rates have increased substantially at the end of December and so far in January. The sharp sell-off in longer-term bonds has created a pullback in stocks. The bond market is selling off due to the vast amount of government deficit funding, which requires massive treasury auctions to sell bonds, on top of Federal Reserve’s monthly selling of bonds from its balance sheet; and the tough tariff talk from the incoming administration. The top performing large cap growth stocks have underperformed so far in the new year. We did have volatility increase in December and expect heightened volatility to continue in 2025, until inflation declines closer to the Fed’s 2% target.
International developed and emerging market stocks were challenged during the fourth quarter, mostly due to the strong U.S. dollar currency movement, which appreciated against the Euro, Chinese Yuan and Japanese Yen, reducing stock and bond returns priced in U.S. dollars. Both international developed markets and emerging markets have a much lower valuation than the U.S. stock market and continue to be an important part of our diversification.
We remain cautious due to the high valuation of U.S. large cap stocks but remain optimistic on small cap stocks and international asset classes. The S&P 500 Price to Sales ratio is still hovering around 3, which is near its all-time peak of 3.23, reached in December of 2021. Inflation has remained stubborn and remains the most influential factor to determine market movements in the first quarter. The tough tariff talk is still just talk and we do have a historic precedent the last time the administration placed tariffs on China and others, it didn’t create inflation. The uncertainty of how inflation is going to play out is weighing on stocks and bonds. We wish the very best to everyone for an abundant new year and hope to interact with you soon.
For those who would like a deeper dive into the details, please continue reading…
World Asset Class 4th Quarter 2024 Index Returns
The fourth quarter of 2024 was positive for U.S. stocks but negative for all major global equity markets, including real estate. For the total U.S. Stock Market, the fourth quarter return of 2.63% was well above the average quarterly return of 2.4%. International Developed Stocks returned -7.43%, well below the long-term average quarterly return of 1.6%. Emerging Market Stocks returned -8.01%, below the average quarterly return of 2.5%. The worst return was found in Global Real Estate Stocks, which lost -9.02%, well below the asset class’s average quarterly return of 2.2%. The U.S. Bond Market was negative, down -3.06%, below its average quarterly return of 0.9%, while the Global Bond Market (ex U.S.) was up 0.74%, slightly below its average quarterly return of 1.0%.
Here is a look at broad index returns over the past year and longer time periods (annualized):
For full year 2024, U.S. stocks led all broad categories with a positive return of 23.81%, International Developed stocks were up 4.7%, Emerging Markets stocks were up 7.5%, and Global Real Estate stocks were up 2.77%. The U.S. Bond Market gained 1.25% and Global Bonds were up 4.97% for the past year. Over the past five years, U.S. stocks were up 13.86% annually, while International Developed stocks were up 5.1% annually, Emerging Market stocks were up 1.7% annually, and Global Real Estate stocks were up 0.46% annually. The U.S. Bond Market was slightly negative, down -0.33% annually for the past five years, while Global Bonds were up 1.01% annually. Over the past 10 years, the U.S. stock market (up 12.55% annually) is well ahead of International Developed (up 5.26% annually), Emerging Market stocks (up 3.64% annually) and Global Real Estate stocks (up 2.98% annually). U.S. Bonds were up 1.35% and Global Bonds were up 2.43%, annually, over the last 10 years. You can also view annual returns for 15 and 20 years.
Taking a closer look within U.S. stocks during the fourth quarter, Large Cap Growth took the top spot, up 7.07%. well above market wide returns of a gain of 2.63%. Large Cap Value stocks (down -1.98%) were slightly below Small Cap Value stocks (down -1.06%). A challenging quarter for small cap and value stocks, after both did well during the third quarter.
If we extend our analysis of U.S. stocks over longer time periods, Large Growth stocks still led over the past year, up 33.36% and increased the gap over Large Value, up 14.37%. Large Growth has been the top returning asset class over the past 3, 5, 10, 15 and 20 years, outpacing the broad Large Cap category in each of the periods.
The U.S. stock market represents 65% of the global stock market. The U.S. business cycle continues to slow as measured by leading indicators; however, GDP growth continues to exceed expectations and for 2024, GDP growth is expected to be a solid 2.5%, which is far from negative. It is difficult to see a recession with the job market still strong. The four-week moving average of initial claims for unemployment insurance is heading up but remains just above the lowest levels in the last year, which means the U.S. job market remains very tight; and until it falters, we are not likely to experience a recession in the near term.
Moving on to International Developed stocks, which were flat in local currency and negative in dollars for the quarter, due to the strengthening of the U.S. dollar against most major currencies. International stock returns were helped by currencies movements in the third quarter of 2024 but gave back those gains in the fourth quarter. Value stocks led the fourth quarter, losing -6.55%, after currency adjustment (up 0.85% in local currency). Growth Stocks were down the most, -8.31% in U.S. dollars, (down -0.95% in local currency). The Euro went from $1.12 at the end of the third quarter to end the fourth quarter at a value of $1.04. The currency effect served as a strong headwind, hurting international stock returns during the fourth quarter:
Over longer time periods, the value premium (value-growth) is positive for the fourth quarter, over the past one-year period and over the past 3 and 5-year period, but still slightly negative for 10 years, 15 years and 20 years. The size factor premium (small cap-large cap) is slightly negative in the past quarter, negative in the 1-year, 3-year and 5-year periods, and positive for the past 10 years (5.49% vs. 5.26%), 15 years (6.29% vs. 5.25%) and 20 years (5.68% vs.4.95%):
The International Developed Market represents 24% of the global stock market and Emerging Markets represent 10% of the global stock market.
Moving the commentary to fixed income, bond market returns around the world were mixed during the fourth quarter, as yields decreased for short bond maturities, due to the Fed cut, and increased for longer maturities. The yield on the 5-year Treasury Note increased by 80 basis points, ending the quarter at a yield of 4.38%, up from 3.58%. The yield on the 10-year Treasury Note increased by 77 basis points, ending the quarter at a yield of 4.58%, up from 3.81%. And the 30-year Treasury bond yield increased by 64 bps to 4.78%, up from 4.14%. As yields increase, bond prices decline, and higher borrowing costs make it more difficult for consumers and corporations to use debt, including auto loans and mortgages. Here is the U.S. yield curve, and you can see how yields increased for all maturities except those shorter than 6 months (current yield curve in grey, one quarter ago in blue, and one year ago in green):
Looking at fixed income asset classes, the highest fourth quarter bond return was for the shortest duration, 3-Month Treasury Bill Index (up 1.17%), while the worst return was the Government Bond Index Long (long-term Treasuries, down -8.60%). The U.S. High Yield Corporate Bond Index was positive for the quarter (up 0.17%), so bond traders were not concerned about lower quality bonds. The U.S Aggregate Bond Index was down -3.06%. It is worth noting that the long bond index was down -11.91% annually for the past three years, down -5.17% annually over the past five years, and now negative over the last 10 years (-0.61% annually). Long duration bonds can have significantly negative returns during periods of rising interest rates. Here are the fixed income periodic returns:
The stock market considers hundreds of factors to determine asset prices, some more important than others. Currently, inflation is one of the most influential factors for determining asset price movements. The uncertainty of the new administration’s tariff policy and amount of U.S. government debt that mut be sold periodically has increased inflation expectations. However, the Fed could decrease the amount of bonds it sells monthly or even stop quantitative tightening all together to create a bond rally, which would drop interest rates.
One cannot time markets and typically the short term is just noise. Here is a sample of how the world stock markets responded to headline news, during the last quarter and the last year (notice the insert of the second graph that compares the last 12 months to the long term). We encourage you to tune out the financial news, since major news sources have a bias toward negative headlines; and often the headlines of the day have very little to do with the direction of stocks.
CONCLUSION
The fourth quarter ended on a whimper for U.S. stocks, while International Developed and Emerging Market stocks were weak; and the jump in yields hurt bond and real estate returns. The stock market is most concerned about inflation but is supported by better-than-expected GDP growth, a resilient job market and an accommodative Federal Reserve. The valuation of the S&P 500 remains elevated, but international and emerging market stocks and even U.S. small cap stocks are more attractive. This is the reason we hold globally diversified portfolios, which we believe will do well this year.
Our recommendation is to stay disciplined with investments, tune out the news and focus on what you can control with your financial plan in the new year. We are here to help you succeed and look forward to seeing you soon.