Effective Date: December 31, 2024
SUMMARY
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Markets initially rallied following the U.S. presidential elections but lost momentum in the last two weeks of the year after the December FOMC (Federal Open Market Committee) meeting. The meeting suggested fewer interest rate cuts in 2025 and potentially higher inflation. In December, we rebalanced portfolios before the FOMC meeting, keeping allocations close to long-term asset allocation targets, but adopted a slightly more conservative stance during the rebalance. The 2025 outlook is positive because the economy remains steady. However, we anticipate increased market volatility and uncertainty as the incoming administration implements policy and tax changes. Our plan is to monitor developments and adjust portfolio allocations as policies take shape and economic impacts become clearer.
INDEX RETURNS YEAR-TO-DATE
S&P 500
Russell 2000
MSCI EAFE International
MSCI EM Emerging Markets
Barclays Aggregate Bond
10 YR Treasury Yield
24.9%
11.4%
3.5%
6.5%
1.3%
4.6%
Markets initially rallied post-election, a typical response following U.S. presidential elections, driven by optimism about a potentially more business-friendly administration. However, international equities lagged due to concerns over tariff-related rhetoric and U.S. equities declined sharply following the December FOMC meeting. The S&P 500 posted gains for the quarter, while small-cap equities, international equities, and bonds saw losses. Despite a slightly negative quarter overall, all major asset classes had positive returns for the year, buoyed by the Fed’s initiation of a rate-cutting cycle in September. Interestingly, long-term interest rates have risen by nearly 1% since the September rate cut, signaling either optimism about future economic growth or concerns about U.S. debt and deficits.
The FOMC’s December meeting introduced uncertainty. While the Fed typically avoids speculating on fiscal policy, Chairman Powell’s comments suggested that some committee members adjusted their outlooks based on the incoming administration’s potential policies on tariffs and deportations. This shift, coupled with higher inflation projections, contributed to recent market weakness. However, it’s too early to assess the economic impact of these potential policies as they remain speculative until enacted.
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Most strategies are performing well against benchmarks, aided by overweighting positions in U.S. equities, making tactical bond allocations, and underweighting real estate. Rebalancing in December adjusted qualified accounts in portfolios toward a slightly more conservative allocation with:
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2% overweight in U.S. equities
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3% overweight in bonds
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5% underweight in real estate
For non-qualified (taxable) accounts, rebalancing is being done gradually to minimize tax implications, typically when you are adding and/or drawing from your portfolio.
MARKET INDICATORS & OUTLOOK
Positive
Market momentum
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Neutral
US Economy & Earnings
Inflation
Interest rates
Monetary policy
Market indicators
Investor sentiment
Negative
Israel & Ukraine wars
US equity valuations
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Our neutral outlook for 2025 reflects expectations of modest positive portfolio returns driven by steady economic performance. The Atlanta Federal Reserve’s GDPNow model forecasts real GDP growth around 3%, surpassing the 25-year trend of 2%. While U.S. equity valuations are historically high, this is largely driven by the “Magnificent Seven” large-cap tech stocks. Valuations for other S&P 500 companies, value stocks, small-cap stocks, and international equities are more reasonable, presenting potential opportunities for better relative returns.
We anticipate:
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Increased market volatility due to Federal Reserve policy and fiscal policy uncertainty
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A typical 10% market correction during the year, consistent with historical patterns
Our strategy is to maintain allocations near long-term targets and rebalance opportunistically. If markets surge or correct significantly, we will adjust weights to capitalize on opportunities.
Despite these neutral expectations, certain dynamics are worth noting. Market momentum remains positive, one of the most predictive indicators of future returns. However, elevated U.S. equity valuations signal caution, especially given the concentration of gains in a few large-cap tech stocks. Encouragingly, valuations for other market segments, including small-cap stocks, value stocks, and international equities, are more attractive and may offer better relative returns in 2025.
The economic outlook also includes potential fiscal policy changes from the incoming administration. While initial reactions suggest a business-friendly stance, proposed measures like reduced government spending and tariffs introduce uncertainty. History shows that such changes can take time to materialize, making it essential to remain flexible. A reduction in deficits, though challenging, could mitigate long-term risks to the economy.
It is also important to recognize the potential for heightened volatility. Markets often correct 10% annually, and in 2024 we saw four corrections of 5-8%. Such movements are not inherently concerning but instead represent opportunities to rebalance portfolios. Turbulence is expected with the Federal Reserve taking a less supportive stance and fiscal policy still undefined.
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PORTFOLIO IMPLICATIONS & RECOMMENDATIONS
Portfolios remain well-positioned, with incremental conservatism introduced in December’s rebalance. While uncertainty around fiscal policy and Federal Reserve actions may lead to volatility, the economy’s resiliency supports a neutral but positive outlook for 2025. Continued monitoring and timely adjustments will ensure portfolios remain aligned with long-term goals while taking advantage of market conditions.
