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Market Performance

The last month of the year saw investors pare back their winnings on fears of higher interest rates and rising economic uncertainty. The S&P 500 and Dow were down single digits, while the Nasdaq eked out a modest gain. Over the quarter they were up 2.4%, 0.5% and 6.2% respectively and 25%,13%, and 29% over the past 12 months. For the year, mega-cap tech stocks were one of the main drivers of returns with communication services and information technology both up over 35%. AI related optimism and robust economic growth proved to be tailwinds to the overall market.

Mid and small caps reversed the previous quarter’s outperformance and lagged the general market by about 5%. Enthusiasm over the election being in the rearview waned and was instead replaced with inflation jitters and concern over fewer than previously expected Fed rate cuts.

International equities also experienced a challenging end to the year. The broad-based developed market index fell by 2.3% in December and8% for the quarter but ended in positive territory for the year up 3.8%.Emerging markets held up better, but also experienced a year-end drop. After being flat in December and falling almost 8% from October through the end of the year, the index was up just over 8% over the previous 12 months. Much of the declines were due to a strengthening US dollar, rising political upheaval, and wars continuing on two fronts.  

Fixed income also had a weak end to the year with the10-year Treasury yield rising from 4.2% at the end of November to 4.6% at year-end, undoing the dip at the end of the summer that saw the benchmark bond metric falling to 3.8% by the end of September.

The central factor in all these results was rising long-term interests which hit valuations across the board and new information from the Federal Reserve. Despite the fact that the Fed lowered interest rates by 25basis points in December, they revised their expectations for 2025 showing fewer planned interest rate cuts, from four down to two. This signals that the Fed remains cautious about both the economy and inflation and will act on a meeting-by-meeting basis.

Overall, the economy continued to grow with both jobs and consumer sentiment showing renewed positivity. Higher consumer confidence typically means more spending, which should support the economy and add to corporate profits, creating a virtuous circle.

Known Unknowns versus Unknown Unknowns

Now that the nation has elected a president, the uncertainty of who will helm the country is now known. What is still unknown is what sort of legislation the incoming administration pass or attempt to pass. While tax cuts, tariffs and cost cutting seem to be at the forefront, how these will get implemented and the degree to which they will make an impact remains to be seen. In the short-term they are, on balance, positive for the economy and markets. However, in the long-term they could reignite inflation. While we’ve gotten a lot of answers about the next four years, these questions remain.

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Market Performance

Overall, the market seemed to shrug off the unprecedented political events of the summer with almost all sectors across asset classes positive. The three domestic major indices were up with the Dow leading the group at 8.7% gains as improving fundamentals and solid earnings growth supported lofty valuations. Foreign developed and emerging markets were also up between 7.25%and 8%. The former benefiting from a weaker dollar while the latter the beneficiary of the announcement of a major stimulus package in China.

Drilling down in the US markets, the rally continued to broaden with small and mid-caps outpacing larger companies. The small and mid-cap indices were up 10% and 7% on the quarter with lower borrowing rates and favorable sector weightings (financial and industrials over technology and communication services) providing a tailwind to performance.

Fixed income markets were strong throughout the quarter as falling interest rates and inflation continuing to ebb helped support returns over the summer. The US 10-year Treasury yields fell from 4.5% in July to 3.8%by the end of September, with short-term rates dropping considerably faster with the heightened expectation of continued Fed cuts.

Overall, economic data releases showed positive signs, as hiring and consumer spending remained robust, and inflation continued to wane. All this is a constructive backdrop for stocks and bonds alike.

What to Watch Out For

Although the macro environment paints a rosy picture, there continues to be concerns that could derail what has been a banner year for investments. The primary market risk domestically is a further economic slowdown in the months ahead. The Fed will likely monitor the labor market as an indicator. Conversely, if inflation starts to pick up, the central bank may have backed itself into a corner and have to reverse course; an outcome that would have been unthinkable several months ago.

Foreign risks remain as well, with the increasing conflicts in the Middle East and Ukraine dragging on into multiple years. The recent slowdown in China presents a problem to buyers and sellers alike.  

And finally, political tumult will undoubtedly increase leading up to the November election, and maybe beyond. But whichever party occupies the White House in January will struggle to implement many of its goals. As both candidates continue to flesh out their hopeful policies, the likelihood of a split government (one party controlling the executive branch, the other the legislative) seems to be the most probable outcome and the appetite for across-the-aisle bipartisanship to work on overlapping agendas seems to be lacking. While that may be frustrating from a civil standpoint, it’s counterintuitively positive for markets as it doesn’t allow the pendulum to oscillate too quickly, creating a reasonable near-term case for positive market results.

‍Q2 Market Performance

As has been the case for the past year, the main drivers for stock performance were concerns about inflation and optimism for growth stocks. Markets entered April nervous about the inflation outlook, having already pared back expectations to three Fed cuts from five. Persistent inflation readings sent stocks and bonds lower in April. However, with inflation easing in May, both benefited from a more benevolent rate outlook. Even as the Fed signaled that they only expect one rate cut this year, domestic markets regained their footing and rallied to end the quarter in positive territory.

Companies exposed to artificial intelligence continued to outperform other areas of the market. A strong earnings season for US tech companies meant growth stocks were once again the top performing asset class. Large cap growth was up 4.7% for the last three months and 15% on the year. Size and style dictated winners. Large caps are up 18% while small caps are up less than 2%. Growth is up 11%, while value is trailing by 4%.

Fixed income markets also had a solid June to cap off a positive quarter. Returns were supported by falling long-term interest rates as the US10-year Treasury yields ended essentially flat after spiking intra-quarter. On the year, the 10-year has risen from 4% to 4.36%, but the long-term outlook has rounded the corner to the benefit of bond investors.

Overall, inflation improvements caused interest rates to fall in June, which supported stocks and bonds.

What to Watch Out For

While the markets are painting an optimistic picture, there remain concerns. From a market perspective, inflation continues to be the most pressing. We saw this in April when the previous month’s inflation report caused a sell-off. While inflation pressures are improving somewhat, the latent anxiety of price pressure remains.

Additionally, election-related uncertainty is ever increasing. Snap elections in France and the UK saw incumbent parties face strong challenges. Domestically, every day sees a new ripple in the US Elections. November is a long way away, and the markets don’t like uncertainty. Under these circumstances, volatility is to be expected and is normal, especially during general election years which are typically 50% more volatile than other years.

Given the lack of clarity in the elections, it’s important to remember that the best inoculation for political uncertainty is to have a diversified portfolio, rather than to make trades based on potential outcomes that may or may not come to fruition.

As always, don’t hesitate to reach out if you have any questions. Enjoy the rest of your summer!

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Chad & the Longtide team

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