10 Jan 2025
The Fred Claus Slump?
Investors hoping for a Santa Claus rally were left deeply disappointed as investor sentiment took a turn for the worse following a spectacular November. Globally, equities fell by 2.6% in December, with large losses posted by U.S. small caps, REITs, and even U.S. large cap stocks, well, at least on an equal weighted basis; the Mag 7 saved the day for the S&P 500® on a market cap weighted basis.
Overall, the fourth quarter of 2024 closed a year marked by economic resilience, geopolitical tensions, and evolving market dynamics. The U.S. economy continued to show strength, with Gross Domestic Product (GDP0 growth for Q4 estimated at an annualized 2.1%, driven by robust consumer spending and increased business investment (and third quarter GDP was revised upward from 2.8% to 3.1%). In December, the Federal Reserve lowered the fed funds rate to the 4.25%-4.50% range, but persistent inflation concerns have reduced the odds of a January cut to only 7% presently. Even as the headline Consumer Price Index showed a year-over-year increase of only 2.7% in November, down from 3.1% one year ago, indicating progress in inflation moderation.
Economic activity in the Eurozone remained subdued, with third quarter GDP coming in at 0.9%. The European Central Bank is on a more aggressive rate cutting path than the Fed and made its fourth 25 basis point cut in December, bringing the borrowing rate down to 3% from a high of 4% in June. Conversely, the Bank of Japan has continued to raise rates and expectations are for another 55-basis point increase in 2025. Related, the Japanese Yen is at a 50-year low against the U.S. dollar according to MRB Partners and JPMorgan, but given the trajectory of rates, that likely won’t last.
While the Taiwanese stock market finished number one for the year, the eyes of the investing world were once again on the S&P 500 generally, and the Mag 7 specifically, which accounted for 53% of the S&P’s return for the year. But it is noteworthy that 36 of the top 50 stocks in terms of performance within the MSCI All Country World Index were domiciled outside of the U.S. Believe it or not, there have been and continue to be attractive opportunities abroad. Although the greenback has obfuscated those opportunities, its strength put a major dent in the return to foreign stocks for U.S. based investors, reducing an 11.3% return for international developed large caps in local currency terms to only 3.8% in dollar terms for the year.
Overall, the year 2024 will remembered for the performance of NVIDIA (+171%), Meta (+66%), Tesla (63%), Amazon (44%), Alphabet (+36%), and Apple (+31%) – Microsoft underperformed at only 13% – and for the fact that U.S. large caps, despite solid earnings growth, ended at extremely high valuations. Perhaps 2025 will be the year when investors once again wake up to the fact that paying less for a dollar of earnings makes sense.
What happened in the markets during the quarter?
EQUITIES: A BAD ENDING TO A PROMISING QUARTER
Stocks tumbled in December, with smaller names underperforming their large cap brethren, but for the quarter, despite all the hype around large growth stocks, microcaps took the top spot, returning 5.9%. Nonetheless, the final quarter of the year was not kind to most equity investors. While the S&P ended higher, the equal weighted S&P fell by 1.9%, small caps returned -0.6%, emerging markets lost 8%, international developed stocks fell by 8.1%, and international small caps retreated by 8.4%.
Market breadth in December, as measured by the percentage of constituent stocks that outperformed the S&P 500, hit an all-time low going back to 1986 (source: BofA). But fundamentals remain solid. According to S&P Global, preliminary results for Q3 2024 indicate that both earnings and sales for the S&P 500 set a new quarterly record, as margins remain high at 11.80%. And JPMorgan estimates that small cap earnings will grow by 44% year-over-year in 2025, after declining in each of the two prior years.
BONDS: A BEAR STEEPENER
The yield curve steepened in December with the yield on the 10-year Treasury rising by 40 basis points (bps) while the 3-month fell by 21 bps and the 2-year increased by only 12 bps. For the quarter the 10-year yield increased by 0.8% leaving it at 4.6%. Bond investors had cheered earlier in the year as rates fell, but the fourth quarter was anything but festive. While bank loans / floating rate notes not only held up, but generated a solid 2.3% return, and high yield bonds eked out a 0.15% gain, the rest of the fixed income landscape was ugly. The bond market as a whole was off by 3%, TIPS lost 2.9%, investment grade corporates returned -3.1%, and long-term Treasuries sold off to the tune of 8.8%
For much of the year, many bond investors were adding duration on the thesis that rates had peaked and would be coming down, but that didn’t work out so well. And with market participants now forecasting higher for longer, for even longer, flows to floating rate notes have spiked again. Related, Collateralized Loan Obligation (CLO) activity remained robust this year and forecasts for next year are quite strong. And high yield spreads ended at a level not seen since 2007 as investors hunt for yield and show no fear of a credit event anytime soon.
COMMODITIES: ANOTHER LACKLUSTER QUARTER AND YEAR
With a loss of 0.5% for the quarter, commodities ended the year with a return of 5.4%. While that was sufficient to beat inflation, it wasn’t by much and it caps a 15-year period over which commodities have annualized at -1.0%. Investing in energy, agriculture, and metals has not been a ticket to wealth and fame.
But as always, there are winners and losers. Crude oil perked up over the final three months of the year, advancing by 8.3%, influenced by geopolitical tensions in the Middle East and Ukraine, stimulus efforts in China, and speculation regarding OPEC production cuts. Natural gas finished on a high note, gaining over 10% in December on a drop in temperatures nationwide, but was only modestly positive for the quarter at 1.2%. But that was about all there was to celebrate in the commodity space. Agriculture fell by 1.2% for the quarter, with soybeans hitting a four-year low due to a substantial Brazilian harvest and wheat futures suffering from increasing global inventories. And both precious metals (-2.1%) and industrial metals (-7.7%) lost ground, the former on an evolving interest rate environment and the later on China’s economic troubles.
How are Frontier strategies positioned?
ALLOCATION CHANGES
Due to the complexities of attempting to generalize about allocation changes across our Core, Specialty, Tax-Managed, Multi-Asset Income, Active ETF, and Faith-Based Strategies, and the additional difficulties of properly conveying how those asset allocation changes flow through to trade level activity, we are instead directing clients to our monthly trade summaries, which describe in detail what trade activity occurred by strategy, and why.
Focusing on our Core Strategies, relative to their long-term asset allocations, which serve as policy portfolios guiding our dynamic allocation decisions, we favor U.S. and international small caps, emerging market equities, managed futures, floating rate loans, and cash/short term bonds. We are generally underweight U.S. and international large cap stocks, REITs, commodities, and both high-yield and high-quality bonds at the asset allocation level, but differences between the asset allocations and actual exposure at the fund level can and will occur. At the beginning of January, our asset allocation models shifted exposure within most strategies from cash and managed futures to U.S. and international small caps, and high-quality bonds.
After the selloff in December, return expectations for all equity asset classes increased going into January, as did expectations for most fixed income sectors. Further, return expectations for eleven of the sixteen major asset classes that we model and utilize are higher now than one year ago.
PERFORMANCE ATTRIBUTION
There were few bright spots for the quarter after a cruel December wiped out sizeable gains achieved in the prior month. The only two major asset classes that were positive were U.S. large cap stocks and bank loans / floating rate notes. The former we were underweight, which hurt performance. The latter we were overweight in a number of our more conservative strategies and that boosted performance. Certain managed futures strategies that we utilize eked out flat to slightly positive returns as well, although that was not universal in the space, and other funds clearly detracted from overall performance. While U.S. small caps outperformed their large cap peers on an equal-weighted basis, the Mag 7 once again propelled the market cap weighted index to a sizeable advantage over small caps, and that was a headwind to absolute and relative returns. And all foreign equities – developed and emerging – hurt performance on a relative basis, primarily because of the rise of the U.S. dollar rather than the performance of the equities themselves. We were generally overweight international small caps and emerging markets and so suffered a setback as a result.
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Inflation is the decline of purchasing power of a given currency over time. A quantitative estimate of the rate at which the decline in purchasing power occurs can be reflected in the increase of an average price level of a basket of selected goods and services in an economy over some period of time. The rise in the general level of prices often expressed as a percentage, means that a unit of currency effectively buys less than it did in prior periods.
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| ASSET CLASS | INDEX | INDEX DESCRIPTION |
| U.S. Large Cap Growth | S&P 500 Growth | Measures the performance of the large-capitalization growth stocks in the U.S. equity market. |
| U.S. Small Cap Growth | S&P 600 Growth | Covers roughly the small-cap growth range of American stocks, using a capitalization-weighted index. |
| U.S. Infrastructure | S&P Global Infrastructure | A stock market index that tracks the performance of 75 of the biggest publicly listed companies in the global infrastructure industry. |
| International Developed Equity | MSCI EAFE | An equity index which captures small-cap representation across 21 Developed Markets countries around the world, excluding the U.S. and Canada. |
| Chinese Equity | MSCI China | Captures large and mid cap representation across China A shares, H shares, B shares, Red chips, P chips and foreign listings (e.g. ADRs). |
| Global Equity | MSCI All Country World | A stock index designed to track broad global equity-market performance |
| Emerging Market Equity | MSCI Emerging Markets | Captures large and mid-cap representation across 24 Emerging Markets (EM) countries. |
| Investment Grade Corporates | Morningstar US Corporate Bond | Measures the performance of fixed-rate, investment-grade USD-denominated corporate bonds with maturities over one year. |
| High Yield Bonds | Morningstar U.S. High Yield Bonds | Measures the performance of USD-denominated high-yield corporate debt. It is market-capitalization weighted. |
| TIPS | Morningstar US TIPS | Represents inflation-protected securities issued by the U.S. Treasury. |
| Leveraged Loans | S&P / LSTA U.S. Leveraged Loan 100 | Designed to reflect the performance of the largest facilities in the leveraged loan market. |
| Long-Term Treasuries | Morningstar US 10+ Yr Treasury Bond | Measures the performance of fixed-rate, investment-grade USD-denominated Treasury bonds with maturities greater than ten years. |
| Municipal Bonds | Morningstar US Municipal Bond | Measures the performance of fixed-rate, investment-grade USD denominated tax-exempt debt issued by U.S. state, U.S territory, and local government entities with maturities greater than one year. |
| REITS | FTSE NAREIT Equity REIT | A free-float adjusted, market capitalization-weighted index of U.S. equity REITs. |
| Commodities | Bloomberg Commodity | Broadly diversified index that allows investors to track commodity futures through a single, simple measure. The DJ-UBSCISM is composed of futures contracts on physical commodities. |