Altair Insight: A Running Start (4Q2024) – Quarterly Market Review

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“If you do not expect the unexpected, you will not find it.” – Heraclitus

Yes, we reached back to 500 B.C. for an aphorism we feel sets the tone for an especially hard-to-predict 2025. Investors should definitely expect the unexpected in the second presidential term of Donald Trump, as we do. Otherwise, as our wise Greek philosopher suggested, you may underestimate risk and be unprepared for new opportunities. Trump II brings heightened uncertainty along with change and turbulence to a new-look Washington.

The new president got off to a running start even before taking over the Oval Office from Joe Biden, outlining ambitious plans for his first 100 days that he began putting into action from Day 1. Even as we go to press, he is in the midst of signing scores of executive orders in his first days in office that could have major implications for the economy and markets. Whether via executive orders or legislative approval, aggressive import tariffs, further tax cuts, strict immigration curbs, expanded deregulation and smaller government clearly are top priorities for the 47th president.

Noah Kroese Illustration for Altair Advisers.

President Trump’s focus on U.S. business interests bodes well for economic growth, while tariffs pose a significant earnings risk for multinational companies in particular. His unconventional Cabinet choices and push for government shrinkage through DOGE (Department of Government Efficiency) create a broad range of possible outcomes. Our outlook is on balance positive, and it was encouraging to see that he expressed an early willingness to negotiate on tariffs rather than immediately imposing the harsh measures that markets feared. However, given the major questions that surround the extent, timing and impact of his initiatives, we are in wait-and-see mode as investors.

We have been studying markets’ up-and-down movements in response to Trump’s various plans and declarations since the election as well as reviewing the statements and actions of the 45th president (Trump I). Any conclusions drawn from his first term can only go so far. He has a new team, four years’ experience in the Oval Office, and full sway over a Republican Congress (albeit with a slim margin) to better back his efforts to carry out ambitious plans. In other words, we do not expect a rerun. His first week quickly made clear that he is ready to move much more forcefully on his initiatives this time. As Heraclitus also said, “No man ever steps in the same river twice, for it’s not the same river and he’s not the same man.”

President Trump keeps a close eye on the stock market as a barometer of his success. We expect he will adapt and adjust policy with the market in mind between now and 2026 midterm elections that could strengthen or weaken his support. The S&P 500 was up 25% in the first two years after he was elected in 2016, even though the ride was bumpy. He surely hopes that extending the 2017 tax cuts and deregulation can help achieve similar results this time.

We are not making any immediate portfolio changes as we watch to see which of Trump’s priorities and pledges become enacted policy, and how soon. We remain confident in our current diversified allocations and retain our tactical overweight positions to U.S. large- and small-cap stocks and recommend our clients remain at target portfolio allocations in the higher-, medium- and lower-risk categories.

All eyes are on the new president, but plenty of other topics have our attention as we move into 2025: The still-strong economy, a looming trade war, paused progress on inflation and interest-rate cuts, bond-market pessimism and the shifting global outlook. Please read on for further discussion of these issues.

  1. The U.S. economic outlook remains bright with consumers and the labor market holding up well.

Looking back at one’s own investment commentary from a year ago can be wince-inducing because of the misses that go along with the hits. Last January, for example, we reaffirmed our overweight position in U.S. stocks but said they would be hard-pressed to match the prior year’s strong double-digit gains. In fact, the S&P 500 virtually duplicated them with a 25% return.

Markets and predictions aside, however, what really struck us was how closely our outlook for the 2024 economy mirrors our expectations for 2025. “A recession appears unlikely in the near future. … The U.S. economy appears headed for a soft landing. … The strength of consumers and the labor market suggest the economy can endure a slowdown in growth before ultimately gaining renewed momentum from lower interest rates. … The Fed’s rate reversal should be a tailwind for both the economy and markets.” Many circumstances are different a year later, including interest rates and the U.S. presidency, but those observations still apply today.

If anything, the outlook is even brighter. While global growth is positive but sluggish, the International Monetary Fund hailed the dominance of the world’s leading economy in raising its 2025 U.S. growth estimate to 2.7%, up half a percentage point since their October forecast. Among the reasons cited: Low unemployment, rising incomes, strong consumer spending, higher business investment and the wealth effect of the nearly 2½-year-old bull market.

The biggest wild cards for the economy this year are Trump’s tariffs and his plans to deport record numbers of undocumented immigrants. New tariffs could cost the average household close to $3,000 next year, according to estimates from the nonpartisan Tax Policy Center. And deporting just 1.3 million of the estimated 10 million unauthorized workers would cause employment to fall by 0.6% and hurt production even more, according to the Washington, D.C.-based Peterson Institute for International Economics. Those estimates are largely speculative, made before we know the extent of actions to be taken in either area. Beyond those risks, the economy’s continued expansion could be jeopardized by another flareup of inflation that has the potential to arise from ambitious government spending plans as well as tariffs.

Overall, however, key measures of both economic fundamentals and business and investor sentiment point to the likelihood of a strong year ahead.

Consumers continue to carry two-thirds of the economy without faltering. Credit card delinquencies that have risen to their highest level since 2011 after five consecutive quarters of increases show they are being increasingly tested. But retail spending has barely wavered as consumers benefit from low (4.1%) unemployment, wage growth (3.9%) that has outpaced inflation for the past 17 months, strong household balance sheets and higher home values.

Concerns about a weakening labor market were put to rest for now by a blowout December employment report that revealed a surge of year-end hiring (256,000 new jobs – around 100,000 more than expected). While there may be further cooling ahead, layoffs have been muted.

Despite some mixed indicators in the manufacturing and housing industries, most businesses are on firm footing going into a year when they may face pressure from tariffs on top of already high borrowing costs and above-average inflation. Analysts’ consensus estimate of 14.8% profit growth for S&P 500 companies in 2025 may end up being somewhat on the high side; it usually does. But heavy capital expenditures and companies’ mostly upbeat guidance suggest that 2025 earnings can match or exceed last year’s growth estimated by FactSet at 9.5%.

The return of an outspokenly pro-business president to office has companies anticipating growth. Both small business owners and large corporations’ chief financial officers saw a surge in optimism in the fourth quarter, according to separate surveys. Banks, too, are increasingly willing to lend to consumers, based on a Federal Reserve Board survey of senior lending officers. All that is fueling expectations of a rebound in M&A activity this year, which has mostly been dormant for several years except for AI-focused companies.

We believe the economy is strong enough to pass its coming stress test of tariffs and other pressures.

  1. A trade war looms with the arrival of new tariffs, but we do not think it will be as bad as initially feared.

The word of the year in 2024 was “brain rot,” according to Oxford University Press. An early front-runner for that honor this year surely has to be “tariffs.” Fears of punitive tariffs have rippled across the globe since well before Trump took office. One shipping industry executive characterized the reaction as a “freakout,” with shippers from China and elsewhere frontloading cargo into the U.S. and Beijing preparing a flurry of retaliatory moves even before U.S. tariffs were announced.

We share the concerns about tariffs’ potential impact. Demand for U.S. exports could suffer, a lengthy trade war would inflict pain on American companies and consumers, and harsh import tariffs would be a jolt to the economies of not only China but also Europe, jeopardizing global growth. Relations with the top three U.S. trade partners – Mexico, Canada and China – will suffer. The early months of the Trump administration will likely bring more volatility as initial threats are backed up and tariffs are imposed.

We believe some of these worries are overblown, however, as Trump tries to use the element of surprise and worst-case fears to his advantage. Markets were pleasantly surprised in Week 1 when the president did not immediately impose severe tariffs while suggesting he was open to negotiation. While outcomes remain unpredictable, what is certain is that the author of “The Art of the Deal” enjoys negotiating deals after starting with extreme positions, bluffs and sometimes conflicting threats that he believes give him leverage. We have already seen evidence of these tactics in Trump II.

“Sorry. It’s the way I negotiate,” the president said in a press conference at the G-7 summit in August 2019 when asked about a flurry of statements and moves on the China trade war front. “It’s done very well for me over the years, and it’s doing even better for the country.”

Trump moved relatively slowly on tariffs in his first term, securing broad tax cuts for individuals and businesses in 2017 before imposing tariffs on solar panels and washing machines and then steel and aluminum tariffs in 2018. After the trade war escalated in 2019, his administration agreed to a trade deal with China late that year.

Despite similar concerns about tariffs when he took office in 2017, they did not derail the economy or markets. Inflation remained low, real GDP growth was solid until the pandemic hit in 2020, and the economy added the most manufacturing jobs (263,000) since 1997 in 2018. Markets endured wild swings due to the trade tumult during his four years, but the S&P 500 still rose by double-digit percentages annually with the exception of a 6% loss in 2018 – corresponding with the actual arrival of tariffs.

Circumstances are different this year and the results may be too. The process should move more quickly, for better or worse, given his experience as a self-described “Tariff Man” and his eagerness to resume the tit-for-tat trade battle. He even spoke on the phone with Chinese President Xi Jinping three days before his inauguration, posting afterward that “we will solve many problems together, and starting immediately.” Harsher statements ahead seem likely. But those words did not sound like those of someone settling in for a long-term stand-off.

A lasting trade dispute between the world’s two largest economies, with Europe and others drawn in as well, could not be good for the global outlook. But negotiations could end it sooner than many think. In the words of Dan Clifton, Washington policy research analyst for Strategas Research Partners and the keynote speaker at Altair’s recent investment summit: “We have always viewed Trump’s style as punch the bully in the mouth, hit your opponent hard, and then negotiate down.” We believe Trump’s goal of crafting deals after extracting some concessions and his desire to avoid big trouble for the economy and markets should limit the duration of any trade war beyond an initial slugfest.

  1. Further interest-rate cuts remain likely in 2025 that should bolster the economy and markets.

           Rita: “Do you ever have déjà vu?”

           Phil: “Didn’t you just ask me that?”

    • Groundhog Day (1993)

As Groundhog Day approaches, it feels like we are reliving the early days of last year when inflation hovered near 3% and investors eagerly awaited a rate cut by the Federal Reserve that turned out to be months away. Wall Street is more wary this time around, having seen this movie before. Traders anticipate that there might be as few as one quarter-point cut this year, following the three of last fall that in total reduced the Fed funds rate by 1%.

We believe market expectations for minimal rate cuts are overly negative. (A year ago they were the opposite: Markets predicted five or more cuts, which we called unlikely. There were three.) Continued modest economic growth coupled with no upsurge in inflation – our base case – should allow the Fed to resume its task of lowering the benchmark interest rate. The Trump administration, aware that high inflation helped doom its predecessor, already is scouring for spending cuts to reduce the risk that tariffs and other initiatives reignite prices.

Inflation has cooled but remains stubbornly sticky. We expect it to continue to be bumpy but also to slowly trend lower throughout the year, even though it may not get to the 2% target by the end of 2025. Given that downward path, we believe the Fed will keep cutting barring an unexpected surge in inflation – making two to three quarter-point reductions this year, versus the one to two cuts that traders gauged by the CME FedWatch Tool currently anticipate. We expect those cuts to add to the tailwind of the 2024 reductions as they become increasingly evident for consumers, borrowers and companies this year.

Recent comments by Federal Reserve Governor Christopher Waller pointed a way toward another cut coming sooner rather than later, contrasting with market expectations. Waller said the Fed could lower rates again in the first half of this year – perhaps even as soon as March – if data continue to be favorable. “I’m optimistic that this disinflationary trend will continue and we’ll get back closer to 2% a little quicker than maybe others are thinking,” he said on CNBC.

Optimism by a Fed official about inflation has not always been borne out and may not be the prevailing view. Minutes of the Fed’s December meeting showed that, due partly to coming changes in trade and immigration policy, reaching 2% “could take longer than previously anticipated.”

A repeat of the encouraging inflation data released in mid-January, while hardly assured, could clear the way for multiple cuts this year. It showed underlying inflationary pressures easing even as the Consumer Price Index edged up to 2.9%. More notable than that number, nearly half of which was accounted for by a surge in gasoline prices, was the first decline in core inflation since June, to 3.2%. Housing (shelter) prices, which comprise a third of the CPI weighting and have long been a troublesome sticking point, saw their smallest year-over-year gain (4.6%) since January 2022. Excluding shelter, inflation has essentially been around the 2% target since 2023.

Inflation may be the key economic gauge to watch in 2025 for its influence on what happens with interest rates and the markets. But a return to runaway inflation appears unlikely either in the U.S. or abroad, where other central banks also are poised to continue easing monetary policy as price pressures decrease.

  1. Trump’s market-friendly agenda and AI momentum should help offset risks for stocks.

Buckle up for what we expect to be a turbulent but ultimately positive ride in financial markets.

We believe markets will be boosted by a combination of factors that should provide another year of gains in the face of substantial challenges, even though U.S. returns are unlikely to match the blistering pace of the past two years. Our outlook remains positive despite the December downturn and the overhang of still-elevated rates and inflation. It is supported by the following expected tailwinds, which we touched on earlier:

The new administration’s pro-business policies: Deregulation of the financial and energy industries in particular should boost businesses’ earnings and investor appeal. Trump’s plans to expedite approvals and permits for any company that invests $1 billion in the U.S. should attract more investment dollars from both this country and abroad. There was early evidence of his support for business when on Day 2 of his term he announced billions of dollars in private sector investment to build artificial intelligence infrastructure.

The U.S. economy’s vigor: The 1-2 punch of consumers and the labor market continues to power an economy that has yet to slow despite expectations. As the IMF summarized in its World Economic Outlook in January: “In the United States, underlying demand remains robust.”

Tax cuts: The likely extension of the 2017 tax cuts for individuals coupled with a reduction of corporate tax rates should not only further stimulate economic activity but ensure more investment in the stock market. At a minimum, these actions should help reduce chances of a sustained downturn.

Artificial intelligence: Intense capital spending by the mega-companies leading the world – and the stock market – on AI shows no sign of letting up. Companies are still in the early stages of boosting productivity by using artificial intelligence to automate operations and make their staffs more efficient. The Magnificent Seven continue to lead the way, but medium-sized and small firms too are adopting AI. Although the excitement regarding AI has produced some excesses and frothiness for a select group of stocks, the growth, profitability and increased productivity of many companies riding the AI wave should discourage any broad comparisons to the dotcom boom that went bust.

Further market upside could come from a broadening like the trend that took hold in 2024 before fading in the year-end sell-off. Some industries, such as housing and industrials, have taken longer to recover than technology and other high-fliers from the pandemic and high rates. Small-cap stocks have fallen by double-digit percentages since November as markets fret about interest rates staying high as the economy remains strong. We believe they may be oversold and a comeback is coming.

While past performance does not guarantee future results, previous instances in which the S&P 500 delivered 20+% returns in consecutive years, as it did in 2023 and 2024, were usually followed by more gains in Year 3. Back-to-back boom years with returns of above 20% have occurred eight prior times since 1950, with the S&P rising six times in the subsequent year with an average gain of 12.2%. Only twice was the third year negative.

Our outlook is more measured for the near term in some areas of the market.

REITs continue to trade at attractive levels by historical standards, but performance remains correlated to moves in long-term interest rates. Even if short-term rates are cut more than expected, longer term rates can remain elevated. Commercial property prices recently turned positive after almost three straight years of declines, providing hope for investors.

Bonds are subject to more near-term volatility given the uncertainty of how Trump’s policies will affect interest rates, although ultimately we think they will deliver positive returns. Bond yields typically fall when interest rates go down, which is good for bond investments. (Bond prices move inversely to yields.) But concerns that the strong economy and Trump’s tariffs and spending ambitions could be inflationary and forestall further Fed rate cuts have pushed the yield on the benchmark U.S. 10-year Treasury note closer to the rarely seen 5% level, reached only twice (in 2007 and briefly in 2023) in the past quarter-century, hurting existing bonds.

International stocks, which have underperformed their U.S. peers for far longer than expected, have been further beaten up by the threat of tariffs. While those concerns are legitimate, we do not believe President Trump wants the all-out trade war that many investors seem to be anticipating given the negative impact it could have on all stocks. It also is important to remember that both developed and emerging markets saw a major rebound after the initial declines that followed Trump’s election in 2016. It could happen again.

Will this be a comeback year for international stocks? Long-term historical cycles suggest they are overdue for mean reversion – in other words, to begin a cycle of outperformance vs. the U.S. market – but the exact timing is always unknown. International markets have delivered modest gains but lack the technology giants and have been hurt by the dollar’s surge against other currencies. We are underweight global equity but retain international stocks in portfolios for their historically cheap valuations relative to U.S. stocks, less concentration than Mag 7-dominated U.S. stocks, and value as diversifiers to the heavy U.S. focus on growth. Recent corporate earnings abroad have been better than expected, and we believe our recommended managers will take advantage of new opportunities.

  1. The global outlook is shifting in ways that could be positive for economies and investors despite the abundance of concerns.

Geopolitical tensions, never lacking, seem particularly abundant as we move into a new year. Economic policy uncertainty is high due to the many newly elected governments – the U.S., Germany, South Korea, France and Canada among them. The emergence of populist leaders, a rise in authoritarianism, and the likelihood of a trade war have created the conditions for shifting global conditions and alliances. China’s ability to keep the world’s second-largest economy growing at a healthy rate is under its biggest threat since the last Trump presidency, with broader implications for the global economy. Ian Bremmer, president of the Eurasia Group political risk consultancy, calls this “a uniquely dangerous period” for the world.

We do not take these risks lightly. However, from an investment standpoint, the global economy and markets have generally been remarkably stable despite a number of challenges since the global financial crisis of 2007-09. We believe they are likely to ride out the latest risks in 2025.

Two horrific wars that were thought to pose serious threats to the global economy the past two years have had less far-reaching impact than feared. In 2025, a cease-fire has temporarily halted the war in Gaza between Israel and Hamas and one also seems possible between Russia and Ukraine as Trump pushes for a deal.

Iran’s increased weakness and the fall of the Assad regime have altered the Middle East power structure with uncertain and potentially dangerous consequences but at least the hope of less conflict.

Markets have adopted pessimistic views about the global outlook. However, the potential exists for plenty to go right and a resulting lift to international markets. The U.S. dollar’s extreme strength against other currencies will not last indefinitely. A trade war, as we mentioned above, may not be as bad as the negative scenario priced into markets. The European Central Bank may cut its policy rate more than the U.S., spurring growth, investment and exports through currency devaluation. China’s government stimulus may spur consumption.

Every year in the past century has been rife with threats to the stability of financial markets. Yet, with some notable exceptions, most have seen economic growth and positive investment returns. We are optimistic that healthy underlying conditions will produce more of the same in 2025.

Our Outlook

  • The U.S. economy is strong and showing virtually no sign of the slowing that many expected would occur as a consequence of above-normal inflation and elevated interest rates. It should benefit further from the growth priorities of the Trump administration as well as the lagging positive effects of rate cuts.
  • Stiff tariffs would pose a modest near-term challenge for lower inflation but should not provoke economy-wide price increases like those seen in 2022 and 2023. Given the new administration’s push to offset inflationary pressures with spending cuts and deregulation, we do not expect material increases and instead expect inflation to continue its downward path.
  • The Federal Reserve is likely to resume lowering interest rates sooner than the market expects and make 2-3 quarter-point cuts in 2025. Other global central banks also will continue reducing rates barring an unexpected surge in inflation, a boost for slower-growing economies abroad.
  • Markets are likely to experience more volatility as investors react to Trump administration policies. We expect robust corporate earnings and a market-focused president to provide a tailwind for the stock market. The bond market also faces heightened uncertainty in the short term, but we expect bond investments to deliver better returns than last year when they were hurt by rising rates.
  • The dollar’s surge against foreign currencies, which has hurt the performance of international stocks in particular, is unlikely to continue throughout 2025. International stocks remain a core, though smaller, part of our recommended portfolios for their historically cheap valuations, less concentration than Mag 7-dominated U.S. stocks, and value as diversifiers to growth stocks.

Quotes of the Quarter

“The very large global disruptions that started with the pandemic, the war in Ukraine and triggered the largest inflation surge in 40 years are behind us.” – Pierre-Oliver Gourinchas, International Monetary Fund chief economist

“We still have an inflation problem. We’ve made amazing progress on it, but we need to continue to finish the job.” – Beth Hammack, Federal Reserve Bank of Cleveland president

“We’ll impose new tariffs so that the products in our stores will once again be stamped with those beautiful words, ‘Made in the USA.’” – Donald Trump, then president-elect

 

Market Data

U.S. Stocks

The stock market logged mixed results in the fourth quarter to close out a stellar year, propelled by enthusiasm for artificial intelligence, interest-rate cuts and a strong economy. A post-election surge based on investor optimism about the pro-growth agenda of incoming President Trump reversed course in December amid concerns about prospects of fewer rate cuts amid still-sticky inflation. But the market’s main benchmark still ended the year with a second straight annual gain exceeding 20%; the iShares S&P 500 ETF added 2.4% in the quarter for a full-year total return of 24.9%.  The Magnificent Seven stocks regained their momentum after a slower third quarter, playing a key role in the three top-performing sectors: communications services (which includes Alphabet and Meta) +38.9%, information technology (Apple, Microsoft and Nvidia) +35.7%, and consumer discretionary (Amazon and Tesla) +29.1%.

The iShares Russell 2000 ETF settled for a 0.3% quarterly gain after a December sell-off and finished the year with an 11.4% total return. Value stocks, too, were victims of the market’s pullback, posting negative returns at both the large- and small-cap levels. Growth stocks had another dominant year as the large-cap Russell 1000 Growth Index had a total return of 33.1% and the smaller Russell 2000 Growth Index returned 15.1%.

International Stocks

European stocks recorded their largest loss in 2½ years, contributing to a poor quarter for international stocks after a rally had lifted multiple markets to double-digit gains in 2024. Worries about the Trump administration’s planned tariffs and U.S.-first policies weighed on overseas markets and corresponded with a steep drop in most currencies against the dollar. The iShares MSCI EAFE ETF, which tracks stocks in Europe, the United Kingdom, Japan and Australasia, tumbled 8.3% in the quarter to narrow its full-year gain to 3.6%. The dollar’s nearly 8% rise against a basket of other leading currencies was a key factor. Before conversion to dollars, the index was down just 0.6% over three months and up a healthy 11.8% for the year. The pan-European STOXX 600 index retreated 3% in the quarter and was up just under 6% for the year despite a nearly 19% jump in German stocks. The other big market winners, as measured in local currencies, included the tech-heavy Taiwan Stock Exchange (+28%) and Japan’s Nikkei (+19%).

Markets in developing countries also responded negatively to the U.S. election outcome, as well as to China’s economic slowdown, and were down across the board in the quarter. The iShares MSCI Emerging Markets ETF fell 7.2% from October through December to trim its year-to-date gain to 6.5%.

Real Estate

REITs finished with modest yearly returns despite a late-year sell-off that wiped out two-thirds of the index’s year-to-date gain. The Vanguard Real Estate Index Fund, which tracks REITs that purchase logistics facilities, cell towers, office buildings, hotels and other properties, lost 7.6% in the fourth quarter to finish 2024 with a 4.9% total return. Sticky inflation and expectations for fewer rate cuts in 2025 led to declines across all property sectors in December’s worst monthly performance of the year. Still, it left REITs with a second straight annual gain after the prior year’s 13.2% rise. International real estate had a worse year; the Vanguard Global Ex-US Real Estate ETF tumbled 11.9% in the quarter for a 2.5% loss for 2024.

Hedged/Opportunistic

Investments in publicly traded senior bank loans as benchmarked by the Invesco Senior Bank Loan ETF added 2.3% for an 8.2% return in 2024, nearly mirroring results from the year’s prior three quarters. Private credit managers continued to benefit from the higher yields of private loans.

Fixed Income

Bonds finished a positive year on a down note as concerns that President-elect Trump’s policies may add to inflation pushed yields to a seven-month high. The 10-year Treasury note yield rose from 3.7% to 4.6% during the quarter despite two quarter-point cuts to short-term rates by the Fed. Bond prices fall as yields rise. The Vanguard Total Bond Market ETF shed 3.1% in the quarter to shrink its 2024 return to 1.4%.

Altair’s benchmark for municipal bonds, a blend of the Market Vectors short and intermediate ETFs, edged 0.5% lower to end the year with a 1.8% gain. Munis were pressured by the higher-for-longer outlook for interest rates.


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The Closed-End Fund Blended Benchmark consists of 60% First Trust Equity Closed-End Fund TR USD Index, 20% Invesco CEF Income Composite ETF, and 20% VanEck Vectors CEF Municipal Income ETF.

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