Thayer Partners Quarter 4 Investment Commentary Executive Summary: Financial Markets Trim 2024 Gains as Year Closes Federal Reserve Taps the Brakes on Rate Cuts Trump Administration Agenda Looks Aggressive, but Within Limits Massive AI Valuation May be Tested in 2025 Thayer Client Portfolios Maintain Diversification and Moderate Defensive Tilt What happened in the financial markets in the quarter and 2024 as a whole? Following earlier-year gains, stock and bond markets both encountered more challenging conditions as 2024 drew to a close. Thayer client portfolios performed solidly over the year, with robust stock gains, resilient bond returns and a helpful contribution from income strategies. Stocks enjoyed a second consecutive strong calendar year – the S&P 500 and globally inclusive ACWI indices gained 25.5% and 17.5%, respectively – but shed a few percent in December. This perhaps reflected some reality checking as historically elevated valuations calibrated the upcoming year. As expected, the U.S. election carried significant weight. The elevation of a nationalist Donald Trump agenda had a likely hand in pushing up the U.S. dollar; the currency’s index against a basket of other currencies rose 5.8% and 6.7% in the quarter and year, respectively. This in turn contributed to dampened returns for U.S. investors in non-U.S. stocks – the VEA international stock ETF lost a weighty 8.1% in the quarter, leaving the year’s gain at a modest 3.3%. As measured by the broad AGG index, bonds declined 3.1% in the quarter, reducing their 2024 gain to just 1.4%. Bond weakness coincided with the long-awaited pivot in Federal Reserve rate policy, spanning a half percent cut in the September meeting and quarter point cuts in both November and December. While anticipation of the pivot had pushed bond prices higher (and rates lower) in prior months, the actual cuts were met with skepticism about reasoning, amidst signs that inflation was still simmering with economic growth staying robust. This forced a downward adjustment in the Fed’s outlook for further rate cuts in 2025. Where is Fed policy pointing and what is the 2025 GDP outlook? Jay Powell and the Federal Reserve spent 2024 gaming out when to “pivot” to rate cuts, watched closely by investors. Generally, the Powell team would receive high marks for its stewardship since 2022, as inflation eased almost all the way to desirable levels in the wake of an aggressive series of rate hikes, and economic growth remained solidly in the 3% neighborhood, confounding earlier consensus views that the hikes would trigger a recession. As it turned out, the investing, consuming and borrowing public has been able to more quickly enjoy the benefits of higher rates (for example, money market accounts yielding 5% as opposed to just above zero several years ago) than they have had to contend with higher borrowing rates, thanks to the near-term immunity of low fixed rate mortgages and other longer dated loans. But the Fed may have erred later in 2024 by suggesting that two percentage points worth of cuts off the 5.25-5.50% peak would be warranted by the end of 2025, with inflation stubbornly hugging 3%, not the desired 2%, and the unemployment rate still low at 4.2% in November. This led to the December meeting back-track to 1.5% in total expected cuts, meaning just two more quarter point trims this year. To justify even this lesser easing, the Fed could point to some slowing in economic drivers, including recent ebbing in monthly job gains as well as job openings. What are the new administration’s fiscal priorities and possible impact? The incoming Trump team has laid out an ambitious range of policy initiatives, spanning taxation and spending, trade, energy, regulation, inflation and immigration. As the team and agenda come into focus, investors (and others) will need to gauge what it may mean in actual practice. While Republicans start with unified control of both the House and Senate, majorities are slim, particularly in the former chamber. And the window of opportunity is probably short-lived — the first two years, ahead of the 2026 mid-terms. An extension of Trump’s 2017 corporate tax cuts, up for renewal at the end of this year, seems likely, and this would continue to support corporate earnings, while also hindering efforts to rein in Federal budget deficits that uncomfortably hover around $2 trillion. Less clear is the extent to which the administration pursues new tariffs, which sounded appealing on nationalist grounds during the campaign but might run into an inflation wariness that did not exist when the first Trump tariffs were enacted. Efforts to reduce inflation may be mainly staked on energy policy, including an aggressive ramp-up in drilling and oil production, meant to ease prices. Possibly paired with an unwind of net-zero green objectives, this will face challenges. The immigration hard line, well known from the campaign, has run into some resistance within the Trump inner circle, specifically concerning H-1B visas. This work visa allows foreign nationals to work in specialized, highly skilled roles for up to six years. It is strongly favored by both Department of Government Efficiency heads Elon Musk and Vivek Ramaswamy, and it has been defended by Trump himself. As this runs counter to Trump base orthodoxy, this is an interesting conversation, and one that might portend an improved relationship with the economically critical technology sector. Will AI continue to outperform other investments? After two years of dominant investment returns in the AI sector (once again led by Nvidia stock, gaining 171%), its collective market value has reached an estimated $9 trillion. For context, only the U.S. and China have whole GDPs more than that figure ($29 trillion and $18 trillion), with the next three (Germany, Japan and India) all under $5 trillion. At these valuation levels, investors may begin to demand more immediate signs of the heady revenue growth that most expect. As for current results, analysts quoted on the Data Economy website estimate that collective AI capital spending (loosely equating to revenue) grew robustly to $240 billion in 2024, much of it related to AI “infrastructure” – the computing resources needed to run future applications. But while today’s revenues do not seem to support a $9 trillion valuation, the ramp-up should be steep and reach annual trillions relatively soon; the same analysts see AI generating some $20 trillion in cumulative economic impact by 2030. Overall, it might be a lot to expect a new big valuation jump from a level that already is double three of the world’s top five economies. Further, AI’s margin for error seems thin, including an unproven track record during economic cooldowns, if not recessions. Further, we have yet to solve AI’s aggressive power grid ask – a ChatGPT query takes ten times the energy of a Google query (according to NYU economist Scott Galloway). This has raised the profile of nuclear power, but this energy source remains controversial. How are Thayer client portfolios positioned for early 2025? Heading into 2025, we are maintaining a moderately defensive bias in Thayer client portfolios. Long-only equity exposure is at 90% of its benchmark weight, with the difference mostly made up of hedged equity via a liquid alternative fund. Within the equity book we are slightly underweight technology and AI owing to concerns about valuation, touched on above. More traditional, dividend-oriented positions are held on the basis of seemingly more attractive pricing. International equity exposure stays slightly light, about equal in developed markets and under in emerging ones. The bond allocation remains well diversified, and with aggregate maturity/duration still short of the benchmark. As Treasury debt issuance likely becomes ever heavier, the investing audience might greet the excess supply with a demand for higher rates, which would pressure prices. Overall, we expect greater volatility and increased headwinds as we negotiate leadership transitions in the U.S., Canada, as well as key European and other nations. By design, Thayer portfolios are well diversified, and, as we move forward, we maintain a capability to make changes on perceived shifts in the relative appeal of asset groups. We will keep you posted every step of the way. We greatly and seriously appreciate the trust you place in us. We wish you the best in this early new year. David Beckwith, Chief Investment Officer New Year, New Financial Game Plan: 8 Steps To Kickstart 2025 To help start the year strong, here’s a roadmap to organize your finances and set yourself up for a prosperous year. |
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