Stembrook Market Review - Fourth Quarter 2024

2024 extended a very strong trend for equity investors, especially in large cap U.S. stocks, which continued to lead the way in the final quarter, up 2.4%. The S&P 500 finished the year up 25%, capping off two consecutive years of 20% + gains.¹ This strong performance was not felt across global markets. Non-U.S. stocks were down -7.6% in the quarter, and finished the year up 5.5%.² We continue see the strongest source of returns coming from the technology and communications services sectors within the United States. This group of stocks, known as the Magnificent 7 were up 66.9% in 2024.³ We have adjusted our equity allocation towards a market-weight allocation to large cap U.S. equity, while moving our allocation to developed non-U.S. equity back to our strategic target. Rising interest rates put pressure on the bond market, as the Federal Reserve signaled inflationary concerns in the U.S. Investment grade bonds fell by -3.1%, nearly erasing all 2024 gains, but still finished the year up 1.3%.⁴ 

As we transition to a new administration in Washington, we have not made any bets, or aggressive allocation changes due to the election results. Our view is that the incoming administration will make the United States a more business-friendly environment, by reducing regulations and keeping tax rates low. This should help both the economy and equity markets in the short run. We are concerned about potential tariffs that could not only be inflationary for U.S. consumers, but may also restrict global trade, which could hurt the profitability of multinational companies. We also expect higher policy uncertainty, which can lead to an increase in volatility in equity markets. We will continue to monitor policy and tax changes and adjust the portfolio accordingly if deemed necessary. 

Annual Earnings Growth

Large cap U.S. stocks have consistently had stronger earnings growth.

Our proprietary models forecast long-term, pre-tax returns ranging from 3% to 5% for fixed income-like asset classes and 9% to 10% for equity-like asset classes (see Expected Market Returns and Risks table). We maintain target-weight allocations to equities and fixed income. Our more detailed observations and current portfolio positioning are outlined in the following comments. 

Expected Market Returns and Risks 7-10 Year Horizon

A sampling of return expectations produced by our models. Expected returns are projections and are not guaranteed.

Historical Market Returns

Yields Across Asset Classes

Yields are an indicator of future returns. Orange dots show current yields, blue bars show historical ranges.

• In their January 2025 update, the IMF forecasted that world economic output would grow at a 3.3% annualized pace in 2025 and 2026, adjusted for inflation. This is a slight uptick from the 3.2% growth rate in 2024.
• GDP growth in emerging markets remains weaker than average, this is primarily due to weakness in China. India remains the strongest economy in the group, expected to grow by 6.5% again in 2025, down from 8.2% growth in 2023. Overall, the group is expected to grow at a 4.2% pace in 2025, adjusted for inflation.⁵
• Inflation is expected to continue to cool on a global level as most central banks have enacted tighter monetary policies. Global inflation is expected to fall to 4.3% this year, with increased disinflation in developed economies, while emerging economies trail.⁶
• U.S., inflation ticked up slightly in the fourth quarter to finish the year at a 2.9% annualized rate, slightly off the ten year average of 3.0% annualized.⁷
  

• The U.S. Dollar fell by nearly -5% in the third quarter, then soared, up 7.7% in the fourth quarter, ending the year up 7.1%. The strong Dollar hampered non-U.S. equity returns.⁸ 

• Emerging market stocks erased strong gains of the third quarter, falling -8% in the final quarter of the year, ending the year up 7.5%.⁹
• Non-U.S. developed stocks also fell by -8.1% in the quarter, ending the year up 3.8%.¹⁰
• Within the United States, growth oriented NASDAQ stocks continued to build on positive returns, up 4.9% in the quarter and 25.9% for the year.¹¹
• After a very strong third quarter, small cap stocks in the U.S. moderated, down 0.6% in the quarter, finishing the year up 8.7%.¹²

• Rising interest rates presented a difficult fourth quarter for fixed income investments, for what had been a decent year in performance going into October.
• Long-dated bonds were the most adversely impacted by the rise in interest rates, falling by -8.8% in the quarter and ending the year down -6.2%.¹²
• Non-U.S. bonds also had a very weak quarter, falling by -3.9% and ending 2024 down -6.2%.¹³
• High yield bonds, with generally shorter duration, were less impacted by higher interest rates. High yield bonds were up 0.3% in the quarter and closed out the year with very strong performance, up 7.9%.¹⁴

^{Global Asset Class Returns}

Returns are arranged in columns, by year. Each color represents a different asset class. Each year, the leaders and laggards tend to shift. Diversification across a range of asset classes can smooth returns and enhance growth.

• We maintain our neutral duration position in fixed income portfolios as interest rates have risen to levels that are closer to historical averages.
• After a run-up in prices driven by the Chinese equity market, we recently reduced our allocation to emerging markets. The proceeds from this trade were reinvested in core large-cap U.S. equities. 
• As mentioned earlier, we have shifted our allocation towards neutral exposure in large-cap U.S. equities and have reduced our allocation to developed non-U.S. equities. 
• We favor lower priced, value-oriented equities, both in the U.S. and abroad, which tend to outperform the broad market over time, with less volatility. While these stocks did not keep pace with some of the tech-oriented growth names in the first half of 2024, they outperformed in the third quarter. We are optimistic about the return potential going forward.

We continue to focus our efforts on helping you meet your financial objectives by following our disciplined investment approach. Our approach uses return and risk models, incorporating fundamental valuations and tax-efficient strategies. This investment discipline is tailored to your individual situation in our continuing effort to craft and implement your customized investment solution. 

As we approach the tax filing deadline, please do not hesitate to reach out if you or your tax advisor have any questions. In addition, you have until your tax filing date to make a contribution to your IRA or Roth IRA for the 2024 tax year. If you would like to discuss this, please reach out to either of us.

As always, we thank you for placing your trust in our investment management and advice and welcome your questions and comments at any time.

Peter & Tom

Endnotes and Sources:

Text: 

1. Morningstar: S&P 500 TR USD. 12/31/23-12/31/24, 9/30/24-12/31/24.
2. Morningstar: MSCI ACWI Ex USA NR USD.12/31/23-12/31/24, 9/30/24-12/31/24.
3. Morningstar: Bloomberg US Aggregate Bond Total Return. 9/30/24-12/31/24, 12/31/23-12/31/24.
4. Charles Schwab. 12/31/23-12/31/24.
5. IMF World Economic Outlook Update: January 2025.
6. IMF World Economic Outlook: October 2024.
7. Bureau of Labor Statistics: CPI For All Urban Consumers. 12/31/24.
8. Barchart: $DXY—U.S. Dollar Index. 9/30/24-12/31/24, 12/31/23-12/31/24.
9. Morningstar: MSCI EM NR USD. 9/30/24-12/31/24, 12/31/23-12/31/24.
10. Morningstar: MSCI EAFE NR USD. 9/30/24-12/31/24, 12/31/23-12/31/24.
11. Morningstar: NASDAQ 100 TR. 9/30/24-12/31/24, 12/31/23-12/31/24.
12. Morningstar: S&P SmallCap 600 TR. 9/30/24-12/31/24, 12/31/23-12/31/24.
13. Morningstar. Morningstar US 10+ Year Treasury Bond TR. 9/30/24-12/31/24, 12/31/23-12/31/24.
14. Morningstar: FTSE WGBI Non-USD. 9/30/24-12/31/24, 12/31/23-12/31/24.
15. Morningstar: Bloomberg US Corporate High Yield TR USD. 9/30/24-12/31/24, 12/31/23-12/31/24.

Charts: 

Annual Earnings Growth: As of 12/31/24. 

Source: Standard and Poor's, MSCI, Stembrook Research.

Expected Market Returns and Risks, 7-10 Year Horizon: As of 12/31/24.

Source: Stembrook Research.

(1) Volatility is measured in terms of Standard Deviation. Standard deviation is the statistical measurement of dispersion about an average, which depicts how widely a stock or portfolio’s returns varied over a certain period of time. Investors use the standard deviation of historical performance to try to predict the range of returns that is most likely for a given investment. When an investment has a high standard deviation, the predicted range of performance is wide, implying greater volatility. If an investment’s returns follow a normal distribution, then approximately 68 percent of the time they will fall within one standard deviation of the mean return of the investment, and 95 percent of the time within two standard deviations. For example, for a portfolio with a mean annual return of 10 percent and a standard deviation of two percent, you would expect the return to be between 8 and 12 percent about 68 percent of the time, and between 6 and 14 percent about 95 percent of the time. Source: Morningstar.

Historical Market Returns: As 12/31/24.

Source: Morningstar, Stembrook Research.

Indices: Bloomberg Barclays U.S Treasury Bills 1-3 Month Total Return, Bloomberg Barclays Municipal Bond 5 Year (4-6) Total Return, Bloomberg Barclays U.S. Aggregate Bond Total Return, Bloomberg Barclays U.S. Corporate High Yield Total Return, FTSE All Equity REIT Total Return, S&P 500 Composite Total Return, S&P SmallCap 600 Total Return, MSCI EAFE Total Return, MSCI EM (Emerging Markets) Total Return, Consumer Price Index – U.S., S&P 10 Year U.S. TIPS Total Return, Bloomberg Commodity (Total Return) Index.

Yields Across Asset Classes: As of 12/31/24.

Sources: Cash Equivalents Yields since March 1976. Ibbotson, Federal Reserve Bank, Thomson Reuters, Municipal Bond Yields since March 1988. Barclays Capital, Charles Schwab, BofA Merrill Lynch, Standard & Poor's/Investortools Municipal Bond Indices, Investment Grade Bond Yields since March 1976. Barclays Capital, High Yield since December 1984. BofA Merrill Lynch, Barclays Capital, Real Estate (Public) Earnings Yield since March 1976. NAREIT all Equity, Large Cap U.S. Equity Earnings Yield since March 1976. Standard & Poor's, BARRA, Mid Cap U.S. Equity Earnings Yield since June 1991. Standard & Poor's, BARRA, Small Cap U.S. Equity Earnings Yield since December 1993. Standard & Poor’s, BARRA, Developed Europe Equity Earnings Yield since March 1976. MSCI Europe, Standard & Poor's Europe 350, Developed Pacific Equity Earnings Yield since March 1976. MSCI Pacific, S&P/Citi PMI Asia Pacific, S&P Asia 50, Emerging Market Equity Earnings Yield since December 1998, Inflation-Linked Bond Real Yield to Maturity since March 1997. Citi Yield Book, Federal Reserve Bank. Note: Yields are not perfect predictors of future returns and should not be used in isolation.

Global Asset Class Returns: As of 12/31/24.

Source: Thomson Reuters, Bloomberg, Morningstar, Stembrook Research.

Indices: Consumer Price Index – US, U.S. 30-Day Treasury Bills, Bloomberg Barclays U.S. Treasury Bills: 1-3 Month Index, Citigroup Inflation-Linked Index, S&P 10 Year US TIPS Index, Bloomberg Barclays U.S. Aggregate Bond Index, BofA Merrill Lynch U.S. High Yield Cash Pay, Bloomberg Barclays U.S. Corporate High Yield Index, Dow Jones Wilshire REIT Index, FTSE All Equity REIT Index, S&P 500 Composite Total Return, S&P SmallCap 600 Total Return, MSCI EAFE Index, MSCI EM (Emerging Markets) Index, Dow Jones AIG Commodity (Totl Ret) Index, Bloomberg Commodity Index.

Disclosures

This material is intended to inform you of products and services offered by Stembrook Asset Management, LLC (“Stembrook”). Stembrook is a U.S. Securities and Exchange Commission Registered Investment Advisor.

This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument.

We believe the information contained in this material to be reliable but do not warrant its accuracy or completeness. The opinions, estimates, and investment strategies and views expressed in this document constitute the judgment of Stembrook, based on current market conditions and are subject to change without notice. The investment strategies stated here may differ from those expressed for other purposes or in other context.

 Past performance is not indicative of future results.

The obligations and securities sold, offered, or recommended are not deposits and are not insured by the FDIC, the Federal Reserve Bank, or any governmental agency.

The views and strategies described herein may not be suitable for all investors. This material is presented with the understanding that it is not rendering accounting, legal or tax advice. Please consult your legal or tax adviser concerning such matters. 

Important note regarding Stembrook’s capital market expectations.

The capital market expectations developed by Stembrook Asset Management are estimates of both a central tendency of asset class behavior and a probable range of asset class behavior over a long-term horizon. These estimates are one of many inputs used in the portfolio construction process, and should not be used independently. These expectations should not be construed as the returns that will be achieved, but merely those that may be achieved if certain assumptions hold true. Also note that each client's portfolio may differ given specific goals and constraints applied to the portfolio construction process. 

Additional information is available upon request.