Atlantic Edge Insights
January 2025
Market Recap
Stocks:
The S&P 500 gained over 20% in 2024 for the second year in a row. Continuing a trend from 2023, overall market performance was somewhat deceptive, as the S&P 500’s returns were increasingly concentrated in only a few mega-cap stocks known as the Magnificent 7 (NVIDIA, Apple, Amazon, Google, Meta, Microsoft, and Tesla), which continued to benefit from investor enthusiasm around AI and accounted for more than half of the S&P 500’s return for the year. In fact, NVIDIA alone accounted for more than 5% of last year’s return.
International developed stock markets delivered lower, albeit positive, returns when compared to the S&P 500 in 2024. Europe grappled with high energy costs and slower growth, particularly in Germany and Italy. Japan saw moderate gains, supported by a weaker yen and structural reforms that helped boost profitability. Emerging market stocks performed worse than international developed stocks, especially as China grappled with a crisis in its real estate market that could not be overcome by massive government intervention to prop it up.
Bonds:
Bond market returns were positive in 2024 with short-dated bonds performing better than longer dated. Bond investors spent much of the year focused on the Federal Reserve, as interest rates on key government bonds tended to ebb and flow with market predictions on how many cuts the Fed would make during the year. In the first quarter, rates rose as higher-than-expected inflation induced the Fed to keep rates static, before falling in the middle of the year as disinflation continued and the Fed began to signal that they would begin cutting rates. Finally, rates bottomed around the Fed announcement of its first cut in September, before rising against a backdrop of strong economic growth and stalling disinflation that lowered projections for future cuts.
The spread, or difference in yield, on riskier bonds continued a theme from 2023 decreasing from already low levels. The current spread on high yield bonds is at a low not seen since before the Great Financial Crisis of 2007-2008. These spreads are commonly viewed as an early warning sign of a slowing economy, often rising before the stock market begins to fall. Extremely low levels provide an indication that the economy is strong.
US Economy: Economic growth versus Federal Reserve’s tightening policy
​When the Federal Reserve began raising interest rates in 2022, many believed that to bring inflation down interest rates needed to be high enough to slow down the overall economy, potentially inducing a recession. This was often referred to as a “hard landing.” Despite raising the Federal Funds Rate to what Fed Chairman Jerome Powell called “sufficiently restrictive,” the economy continued to grow at a rapid pace as inflation decreased.​
Excess Savings now Exhausted
Consumer demand, fueled by excess savings generated from pandemic era lockdowns and stimulus, drove GDP growth despite headwinds from high inflation and interest rates. However, by the end of 2024 excess savings from the pandemic were largely depleted.
Consumer Loan Delinquncies Trending Higher
While taken alone, we would expect the loss of excess savings to gradually reduce consumer spending. In 2024, as this total approached zero, default rates on consumer loans and credit began to rise. Instead of reducing spending, consumer demand remained high while financial distress rose as credit card delinquencies hit levels not seen in over ten years. If this trend continues, the likelihood of an abrupt reduction in spending, especially if accompanied by rising unemployment, increases.
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While this development is noteworthy and one that bears watching, current levels are still below historical averages as evidenced by the graphic above. Other measures of economic health are positive, like credit spreads, purchasing managers indexes in both manufacturing and services, and small business optimism.
Stock Market Anomalies
Stocks outperforming the S&P 500 at all time low in 2024
Stock market returns, while high, have been incredibly concentrated over the last two years, with less than 1/3 of all stocks outperforming the S&P 500 index, culminating with a record low of 28.2 in 2024. The only time in the history of the index that less than 1/3 of stocks failed to exceed the index was 1998-1999, at the height of the Dot-Com Bubble.
​Earnings Expectations
S&P 500 beat rates, or the percentage of companies that exceed their expected earnings, fell at the end of last year. While they remain higher than average, the stock market tends to rise when beat rates increase and fall when they decrease. Because many of the largest stocks are expensive and have priced in high growth rates, the market is vulnerable to a valuation correction, especially if beat rates remain on a downward trajectory.
​“Don’t Fight the Tape”
Last quarter we warned that you “Don’t fight the tape,” meaning that you avoid investing against the trend. In the three months since we offered this advice, stock trends have begun to shift and the trends that held for most of 2024 have started to turn down.
Portfolio Positioning
Stocks:
Short-term: Market returns in December were lower as market trends reversed. While broader economic trends remain strong, early warning signs below the surface threaten the larger more expensive growth-oriented stocks in 2025. We continue to favor a more diversified portfolio that de-emphasizes high concentrations of these large stocks but remain overweight US stocks relative to international and emerging market stocks.
Last week, we trimmed exposure in small sized companies as well as emerging market stocks to bring your portfolio allocation back towards neutral positioning. Meaning, if your long-term target is 65% stocks, we reduced from 68% to 65%. This does not mean we are bearish on stocks, but seeing the “tape” warning signs, along with a less accommodative Fed Reserve, and extended valuations, we are taking prudent steps to reflect cautiously optimistic positioning.
Internationally, we remain concerned that economic issues in China will continue to provide headwinds for Chinese stocks. We significantly reduced exposure to China several years ago and remain so. European stocks are relatively cheap when compared to US stocks. While we are concerned that valuations in the US have set a high bar for American companies to exceed, far lower valuations in Europe and Japan have set a much lower bar for those companies to outperform expectations.
Long-term: Over the next year we expect corporate earnings growth for large growth stocks to decrease, while earnings growth for the rest of the stock market increases. Over longer periods we expect market concentration to recede substantially from all-time highs. As market concentration recedes, the largest companies should underperform an equally weighted average of all companies. To take advantage of this dynamic we’ve positioned portfolios to hold the largest stocks below their weight in the overall market.
Bonds:
Despite bonds having a positive but low returning year last year, we believe higher yields offered on bonds should provide a larger component for future returns in a diversified portfolio of stocks and bonds. With the bond market pricing in very few rate cuts in 2025, we believe that intermediate-term (5–7-year maturities) bond yields are attractive. We will look for an opportunity to increase exposure to intermediate term bonds in the 1st quarter of 2025 to lock in these higher returns.
Bonds are more attractive today than they have been in the past 15 years.
Atlantic Edge Insights
Matthew Cochran, CFA
Robert Filosa, CFA
Ethan Caldarelli, CFA
Opinions expressed in this commentary may change as conditions warrant and are for informational purposes only. Information contained herein is not intended to be personal investment advice for any specific person for any particular purpose. We utilize information sources that we believe to be reliable but cannot guarantee the accuracy of those sources. Past performance is no guarantee of future performance; investing involves risk and may result in loss of capital. No graph, chart, formula or other device can, in and of itself, be used to determine which securities to buy or sell, or when to buy or sell such securities, or can assist persons in making those decisions. Consider seeking advice from a professional before implementing any investing strategy.
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