January 13, 2025

December delivered a disappointing finish to what was otherwise a rewarding 2024 for diversified investors. Despite a fair amount of tumult and trepidation throughout the year, investors were largely rewarded for staying the course. For the full year, equity markets were predominantly positive with certain market segments, like U.S. Large Cap Technology stocks, seeing quite strong returns. Bond markets were more reserved in their full year returns, weathering a fair amount of volatility in response to changes in the Federal Reserve’s interest rate policy. Impressively, all of this unfolded against of backdrop of domestic economic uncertainty, geopolitical tensions in Eastern Europe and the Middle East, and a contentious U.S. Presidential Election.

Following a particularly strong rally through November, December threw a bit of a damper on domestic equity markets as the S&P 500 Index closed the month down -2.4%. Following the final Federal Open Markets Committee (FOMC) meeting of the year in mid-December where, despite receiving the anticipated quarter-percent cut to short term interest rates, market reaction to Chairman Jerome Powell’s terse commentary was quite severe. The S&P 500 dropped nearly -4% from its level prior to Powell’s press conference on December 18 to its intra-day low for the month on  December 20.¹ Powell’s comments suggested the Committee intends to take a stricter, data-driven approach to future rate cuts based on the progress of inflation and labor market strength. Coming into the month, futures markets reflected expectations of three rate cuts (a total of -0.75% to the Fed Funds rate) over the course of 2025.²

Following Powell’s press conference markets revised expectations to just one full rate cut for all of 2025, a relatively dramatic shift in a short amount of time.² From a broader perspective, despite several minor bouts of volatility in April, August, and December, it was another very strong year for U.S. equities with the S&P 500 returning an impressive 25.0% for all of 2024. In a continuation of recent trends, Technology stocks delivered the lion’s share of gains with other notable contributions from the Financial Services, Communication Services, and Consumer Cyclical sectors. The largest individual contributors were a host of familiar so-called “Magnificent Seven” names including NVIDIA, Apple, Amazon, Meta, Tesla, Microsoft, and Alphabet which were collectively seven of the top ten S&P 500 individual contributors for the year.

Looking ahead to 2025, fears of overconcentration are resurfacing as the top 10 holdings in the S&P 500 now comprise nearly 40% of the index’s total market capitalization.³ In other words, for every $1 invested in the S&P 500 nearly $0.40 is now collectively invested in the Magnificent Seven along with semiconductor producer Broadcom and industrial conglomerate Berkshire Hathaway. While it has been a developing trend over most of the last decade, a narrowing market focus on just a few sectors or a small number of individual companies creates  an intensifying concentration risk for investors moving forward.

Following consecutive years of +20% returns in 2023 and 2024 for the S&P 500 most widely observed valuations, which are stretched by most traditional measures³, may also present a headwind to returns in 2025 and beyond. The new Trump administration’s hardline stance on trade relations and the FOMC’s actions regarding short term interest rates may also weigh on domestic equities as we enter the new year.

If December was relatively unkind to Large Caps, it was downright harsh to U.S. Small Cap stocks. Even before the FOMC meeting the Russell 2000 Index had fallen over 4% since the beginning of the month. The index went on to finish down -8.3% for the full month. The disappointing final month of the year capped off an otherwise satisfactory, but volatile, full-year performance with the Russell 2000 returning 11.5% while weathering 5 separate drawdowns of >5%.⁴ While double-digit annual returns are nothing to scoff at in absolute terms, 2024 marks the fourth consecutive year, and eighth out of the last 10 years, that Small Cap U.S. stocks have underperformed their Large Cap counterparts.

The outlook for Small Caps heading into 2025 is murky. Easing inflation and softening labor markets have relieved some pressure on costs over the last few years. On the other hand, the agenda of the incoming Trump administration presents an uncertain a mix of opportunities, such as decreased regulation and less aggressive government oversight, and challenges, such as increased import costs due to imposed tariffs, heading into the new year.

Despite minor outperformance in December, International Equity markets were not able to make up much ground on the year-to-date performance differential between themselves and their U.S. peers. Developed international stocks, as measured by the MSCI EAFE Index, were down -2.3% for the month while returning just 3.8% for all of 2024. Developed markets have not enjoyed the relatively smooth and robust economic growth that the U.S. has over the past two years. Of the G7 countries (United States, Japan, Germany, United Kingdom, France, Canada, and Italy) only the U.S. has seen positive quarterly Gross Domestic Product (GDP) growth over the last two calendar years.⁵

To compound the issue, a strong U.S. Dollar also hampered U.S.-based investors’ international returns over the year with the Dollar appreciating against most developed market currencies. Broadly, prolonged inflation and a slower recovery in the manufacturing sector have hampered growth but 2024 saw interest rate cuts in the Eurozone and U.K. which could help accelerate economic activity moving forward. Japan was a particularly strong contributor among major developed countries in 2024 with regulatory reforms and top-down government foreign investment initiatives beginning to bear fruit. International markets' attractive valuations heading into 2025, especially relative to their U.S. counterparts, also provide some element of hope for international investors heading into the new year.

Emerging Market equities fared better than Developed Markets in December, falling only -0.1%, and for the full year, returning 7.50%, as measured by the MSCI Emerging Markets (EM) Index. As the three largest constituents of the EM Index China, India, and Taiwan all had particularly strong returns for the full year 2024. After flirting with serious fears of a collapse of the domestic real estate sector in 2023, Xi Jinping’s government committed to an extensive stimulus program designed to stabilize markets late in the year that lead to a strong rally in the fourth quarter.⁵ Elsewhere, Taiwan continues to see strong growth within its technology sector and India has enjoyed a period of strong corporate earnings amid a favorable domestic economic environment.⁶

2025 could present choppier waters for Emerging Markets as the incoming Trump administration continues to promote their tariff initiatives, which could have unpredictable and potentially destabilizing impacts on trade relationships across the globe. However, it should be noted that Emerging Markets were also a strong performer through the entirety of Trump’s first term, trailing only U.S. Large Caps among major asset classes. ⁷

Volatility in bond markets has been a continuing theme throughout 2024 and was especially prescient in December where the Bloomberg U.S. Aggregate Bond Index relinquished over half of its year-to-date returns falling -1.6% for the month. The broad index, which primarily consists of U.S. Government bonds, corporate bonds, and mortgage-backed securities, finished the year at a paltry 1.3% return. Interest rates were particularly volatile on both ends of the curve in December with the 10-year Treasury rate moving up over 0.4% from the beginning of the month to the end and short rates moving down by as much as 0.3% in step with the FOMC’s rate cut.⁸ Returns for most bond sub-asset classes, such as Treasuries, Corporates, and Treasury Inflation-Protected Securities (TIPS) were muted for the year with High Yield Bonds being the positive outlier.

Fixed income markets may see more volatility ahead as FOMC policy and the continued abatement of inflation in the U.S. will likely be a major focus again in 2025. However, bond investors should take some comfort in recognizing that absolute yields on most fixed income sub-sectors are well above their median yields over the last decade, according to data from JP Morgan. So, although the path ahead may be somewhat uncertain, bonds now offer some level of attractive return relative to the last decade or so of ultra-low interest rates.

While December’s performance was not the most satisfying way to bid goodbye to 2024, the year was otherwise exceptional for diversified investors. Investors benefited from notable gains across various sectors, particularly in U.S. equities and technology stocks. Despite concerns over market concentration, inflation, and geopolitical tensions, staying the course in a diversified portfolio proved rewarding. Looking ahead to 2025, the investment landscape remains uncertain, with risks related to U.S. economic policy, interest rate movements, and global trade relationships. Investors will need to navigate these complexities with careful focus on their own risk appetite and long-term investment objectives.

Hunter Brooks
Portfolio Manager