Perspectives

Despite a difficult December, with stocks impacted by a hawkish Fed pivot, rising yields, and uncertainties around potential Trump administration policy initiatives, fourth quarter returns remained slightly positive for equities, with large cap stocks posting their fifth consecutive quarterly gain. For the full year, large caps posted their second consecutive year of 20%+ returns, as the economy managed to avoid a recession, the Fed began its rate-reduction cycle, markets responded positively to the Trump election, and investors ascribed higher multiples to corporate earnings. The S&P 500 Index gained 2.4% for the quarter. Consumer Discretionary, Communication Services, and Information Technology were among the S&P’s strongest sectors, with particular strength by trillion-dollar companies Tesla, Nvidia, Google, Amazon, and Broadcom. Financials also rallied strongly on the back of gains by the money center banks. Weakness among the industrial metals stocks pushed Materials to the bottom of the pack with double-digit losses, while political concerns had the Health Care sector down by a similar amount. Full-year returns for the S&P 500 reached 25.0%, driven by strength in the same four sectors. Yet, these returns belie market trends under the surface, as the Magnificent 7 accounted for nearly half of the gain, with the Equal Weighted S&P 500 up a less impressive 13.0% for the year.

The Russell 2000 Index of small cap stocks participated in the quarter’s rally, although just barely, with a gain of 0.3%. Strong gains across Information Technology were offset by losses in the Health Care sector. For the full year, the Russell 2000 still managed a respectable return of 11.5%. The AI-related names within Information Technology and Industrials, including hardware, software, and data center construction, provided strength within small caps, while the Energy sector was the only one to register a loss for the year.

Growth was the name of the game in 2024, as the growth components of all large-cap sectors outperformed their Value counterparts. This was particularly evident in the Information Technology, Health Care, and Communication Services sectors. In the fourth quarter, Growth outperformed Value by 9.1 %, pushing its full-year advantage to 19.0%. Among small caps, the advantage was not nearly as extreme, with a 2.8% and a 7.1% advantage, respectively. Style factors favored lower quality in the quarter, especially among small caps, as smaller size, low ROE, and non-earners outperformed. For the year, style factors were more mixed, with a slight advantage to quality factors.

The US economy showed surprisingly strong resilience throughout 2024, with the new year expected to be even better with respect to earnings and economic growth. Most economic statistics, especially regarding the labor market, housing, and consumer spending, remain quite strong. Even the ISM Manufacturing Index, a laggard for quite some time now, has been showing improvement, especially in its new orders component. And this backdrop has created a conundrum faced by the Fed, as its latest 25 basis-point cut was combined with a somewhat hawkish statement suggesting only two rate cuts are to be expected in 2025. Inflation has proven to be a bit stubborn relative to the Fed’s 2% target. In addition, uncertainty around various Trump policy initiatives has the Fed less sanguine about further aggressive rate cuts at this time.

Yet, the path of least resistance still appears to be upward, as the growing economy is combined with strong corporate balance sheets to be used for acquisitions, stock buybacks, and dividends. Personal balance sheets remain similarly healthy with high cash balances and record net worth, leaving investors still poised to invest in risk assets and extend the market rally, although perhaps also at risk for potential speculative excess.

Lastly, we remain committed to investing in quality, whether measured by financial ratios, competitive positioning, or management expertise. This can, and does, impact our relative performance when speculative investment characteristics overrule quality factors. However, our experience and historical results give us confidence that quality will continue to outperform in the long term.

With contributions from members of our Domestic Equities Team