We just completed our 17th Annual Economic Outlook Breakfast.
What a great time it was connecting with friends and clients!
Today, I’ll give you a quick recap of the main points we shared by taking a brief look back at a few important data points from 2024. And then we’ll look ahead to see what the data is telling us as we begin 2025.
Chris Shuba returned for his FIFTH appearance as our special guest. He is the Founder, CEO, and “Chief Quant Nerd” at Helios Quantitative Research.
Greg Torretti, portfolio manager at American Century Investments, also joined us for a brief update on the California Municipal Bond market.
If you’ve been to one of our breakfasts before, you know we don’t make predictions. The real risks we’ll face are very likely the ones no one is thinking about right now.
But we can take an unemotional look at the data and put that in context for the year ahead.
Let’s start with a review of our favorite and most popular piece, our Asset Class Returns Quilt for 2025.
You can download your PDF copy here: 2025 Asset Class Returns Quilt
We rank the best performing asset class for each of the last 15 years at the top, down to the worst performing asset class at the bottom. The grey box is a sample diversified mix representing 60% US and International stocks and 40% bonds.
The quilt is just so good at demonstrating how hard it is to pick the top and bottom performing asset class in any given year and the power of diversifying your portfolio over different asset classes.
It was another great year for markets across the board and that’s because the US economy performed really well.
At the top of the 2024 column, we welcome back a returning Champion, US Large Cap Stocks (S&P 500), which produced the first back-to-back year gains of more than 20% since 1998.
The sample diversified portfolio earned the third highest return in 2024 at 11.07%
It’s notable that bonds were a drag on portfolios contributing just 1.25% in return. These are the types of years where bonds take a breather, and stocks bear the load in your portfolio. There will come a time in the years ahead when stocks struggle, and bonds do the heavy lifting.
That said, even though bonds struggled a bit since 2022, the diversified portfolio still delivered an average annual return of 7% per year over the last 15 years with the third lowest risk of all asset classes.
History has shown there is no guarantee that the next 15 years will look the same for the S&P 500 which is why we don’t benchmark your portfolio returns to the S&P. Your benchmark is the personal return you need to earn to accomplish all your goals.
It’s notable that US stocks did really well AND did it with below average volatility.
Out of 250 trading days in a year, only 19 of those days generated a 1% or greater loss. This is compared to the dotted line average of 34 days dating back to 2000. This chart is a reminder that even in strong performance years like 2020 or 2009 sharp market movements are the norm.
2024 is one of those years you love to see and really appreciate, while also recognizing there’s a statistical likelihood of higher volatility ahead in 2025. After two strong years in a row, dare I say, it may be healthy to have a flattish year in the S&P 500. After all, you own other asset classes for a reason.
Regardless, volatility is the price investors pay for the superior long-term performance that has come from owning stocks.
Economic Recap
As we look back on 2024, we celebrated the 2-year anniversary of this Bloomberg headline where “experts” predicted a 100% chance of recession. (I threw in the fake quote of the year from the US Economy.)
Not only did we escape recession again in 2024, but the US economy is expected to have grown by roughly 3% year over year from 2023.
We know we will get another recession someday, but always a good reminder that it’s impossible to base your investment decisions on even the most confident forecasts.
In another sign of economic growth, US companies have continued to be cash and profit producing machines.
Companies in the S&P 500 are projected to have grown their earnings per share in 2024 by almost 9%. With the largest driver coming from margin expansion – essentially these companies are not only growing their top line revenue but they’re becoming more efficient with each dollar earned and sending more profit to the bottom line. (Emphasis in the chart is mine.)
Looking Ahead to 2025
Chris shared data from the three main things on investor’s minds as we enter 2025:
1) The potential policy impacts of the Trump Administration.
2) The Fed’s approach to inflation and rates.
3) Equity market valuations after 2 years of strong growth.
Trump
With regards to Trumps policies, Chris was cautious to point out that his comments to our group are apolitical. As an analyst, his job is just to look at the data from an unemotional point of view.
He argues that Trump has been President before and has a track record on some of these issues. It remains to be seen, but he doesn’t think Trump will go nearly as far on major issues as he espoused on the campaign trail – specifically tariffs (trade war) and immigration. Getting too tough on either can negative impacts on the economy and the stock market. Trump watches both and should be hesitant to damage either.
The Fed
On the back of plateauing inflation data and stable employment, the Fed ultimately cut rates in 2024 but would wait until September. They then delivered a hefty 0.50% cut followed by two more 0.25% cuts before the end of the year.
They have turned hawkish, meaning they are not as committed to lowering rates further in 2025, but Chris argues this is not a bad thing. For the Fed to pause here, means the economy is doing well with continued growth in GDP, stable inflation and employment, and may have achieved a very rare soft landing for the US economy.
The highest odds from the Fed futures market is for just one more 0.25% cut in 2025. We’ll see…
Should I Be Concerned About the Market After 2 Years of High Growth?
For some background, 2024 will rank as the 16th best year for the S&P 500 since 1958. The S&P 500 rose 23.31%, gaining 25.00% on a total return basis.
The S&P 500 would reach 57 new all-time highs, the third most this century.
There were pullbacks from April until May, lasting 47 days, and from July until September, which lasted 64 days without an all-time high. On the other hand, there were several instances of a 4 consecutive day streak of new highs set. For the past 24 years, most of the records for new highs have been set over the last 10 years.
The “lost decade” becomes apparent when viewed through the lack of record highs reached in the 2000s.
The data tells us a strong year doesn’t necessarily foretell much about the following year. Two good years in row doesn’t mean the next is destined to be tough.
Across the best 20 calendar years, the next year tends to rise by 8.78%, above longer-term averages, but still within reason.
However, outcomes have varied widely, ranging from a 19% loss to a 31% gain. Market corrections (loss of at least 10%) happen roughly half of the time following banner years in the S&P 500, though the worst next-year drawdown in this sample set happened during the initial pandemic crash.
This is confirmation it’s best to stay the course with your well-defined, goals-based asset allocation, and to expect volatility in stocks…just as you normally do.
Bottom Line
The expectation is that the US economy will be “good enough” to support positive equity markets – even in light of a new administration.
Stock valuations are high and that’s reflected in the concentration of stocks in the S&P 500 index. The top 10 stocks currently make up 37% of the index. But the free cash flow margins of these top 10 stocks are the highest they’ve been going back to the 1950s. Said another way, these companies are so far earning their lofty valuations.
You generally own bonds in a portfolio for two reasons, 1) income and 2) diversification. With the expectation that rates stay elevated, certainly compared to the last 15 years or so, bonds are spitting off attractive income again.
Finally, after a pretty mild year for volatility in US stocks, it’s best to expect “normal” sharp downturns and recoveries. As we’ve stated in previous outlooks and blog posts and social media, the average intra-year downturn for the S&P 500 has been 14% since 1990. Stocks go down regularly in any given year, even though 80% of those years since 1990 finishing with a positive return.
California Municipal Bond Market
As I mentioned at the top, we closed out the event with a quick presentation from Greg Torretti who discussed the current state of the California Municipal Bond market.
You might be asking the very obvious question, why would we want to talk about California municipal bonds?
Given the make-up our clientele, a large number of our firm's assets are in some form of Cal Munis or Cal Muni Money Market Funds.
Two states account for one-third of the total municipal bond market – California and New York.
What is the benefit of owning municipals? For residents of a high-income tax state like California, the interest received from these bonds is exempt from both Federal and State income taxes.
Greg shared just how attractive Cal Muni’s are for those in the top income tax brackets – especially with interest rates elevated.
As of 12/31/2024 the yield on the American Century CA Intermediate Term bond fund (BCTIX) was 3.11%. For those in the highest income tax brackets that’s equivalent to a 6.6% yield (at 53% combined Federal and CA State income tax rate).
In addition, California Munis have a high credit quality, second only to US Treasuries. California would have the 5th largest GDP in the world if it were a stand-alone country. And, Cal munis have diversification benefits with a low correlation to US stocks.
It’s too soon to really understand the impact to bonds issued by the municipalities in Southern California that sadly just experienced horrific fires and mass destruction. However, he noted that LA County has a very large economic base with an accessed value of about $2.0 trillion versus estimated damages from all the fires at $50 billion (2.5% of County assessed value.) So, there may be some short term volatility in that segment of the bond market but the fiscal impact to the issuers may be small.
Cheers to a happy and successful 2025!
Please reach out if you’d like to discuss our outlook or how California Municipals work in your portfolios.
Happy planning,
Brian