Photo credit: Saul Loeb/AFP/Getty
INVESTMENT ENVIRONMENT1
Source: Orion Advisor Services, AlphaGlider
The reelection of Donald Trump to the White House drove very divergent investment outcomes during the fourth quarter of 2024. Large cap US growth equities and cryptocurrencies were big winners, while foreign equities, US value and quality equities, global fixed income, and global real estate all took it on the chin. The overall US equity market, as measured by the S&P 500,^a posted a total return of 2.3%, while emerging and foreign developed markets were both down approximately 8%, as measured by MSCI Emerging Marketsc and MSCI EAFE,b respectively. US fixed income, as measured by the Bloomberg US Aggregate Index,e declined just over 3%.
The US equity market also led the way over the entirety of 2024, posting a 24.5% gain. Including 2023’s 25.7% gain, the US equity market put up its best two-year performance in a quarter-century. It was a respectable, but fairly pedestrian year for foreign equities, with emerging markets and developed markets returning 7.5% and 3.8%, respectively. Same for fixed income, with the Bloomberg US Aggregate Index up only 1.3%.
The US economy remained on its “soft landing” glide path during the quarter. Just over a quarter million jobs were added in December—the most since March 2024 and about 100,000 more than economists had expected. The unemployment rate ticked down to 4.1% in December, and retail sales for calendar 2024 were up 4% over 2023. The US dollar surged in value against most other major currencies.
Inflation continues to be the one blemish on the US economy. Progress towards the Federal Reserve’s 2% inflation target (as measured by the Personal Consumption Expenditures (PCE) Price Index) stalled in the second half of 2024 (chart on right is for a related inflation gauge, Consumer Price Index (CPI)). However, this did not keep the Fed from cutting its overnight rate another 50 basis points (i.e. 0.5 percentage points) during the fourth quarter, just as it did in the third quarter. The Fed Funds rate now stands in the range of 4.25%-4.5%.
Something peculiar happened when the Fed began cutting its overnight rate last September — the market started driving up longer duration rates. While the Fed cut three times for a total of 100 basis points, the market drove up the yield on the 10-year Treasury by 115 basis points (as of 10 January; see chart below). This is highly unusual compared with prior periods of Fed rate cuts and seems to be indicative of the market’s concerns about the pace of inflation over the longer-term. It is also a reminder that while the Fed controls short-term interest rates, longer-term rates are set by the bond market based on the outlook for inflation, growth, deficits, and more.
Source: Koyfin, AlphaGlider
Why the sudden change in the market’s outlook? The reelection of Donald Trump. His announced agenda of more tariffs, fewer regulations, renewed and expanded tax cuts, and mass deportations will likely be highly inflationary and accelerate the growth of the country’s already large debt burden if enacted. Less certain is the agenda’s impact on the long-term growth of the US economy, with tax cuts and deregulation spurring growth, but tariffs and mass deportations holding it back.
Source: JP Morgan Asset Management
On the left is one fund management’s estimate of the incremental impact of Trump’s announced agenda on the US budget deficit over the next decade—nearly $4 trillion dollars. These are big numbers that can be hard to get one’s head around, so looking at the potential impact as a percent of the size of the US economy (as measured by the gross domestic product, or GDP for short) and how it deviates from the trajectory under current law, can be easier to understand. The chart below, created by the bipartisan Committee for a Responsible Federal Budget (CRFB), shows US debt rising from approximately 100% of GDP in 2024 to 125% in 2035 under current law (see black line). This troubling projection includes the benefits from the expiration of costly tax breaks brought in by Trump’s Tax Cuts and Jobs Act (TCJA) of 2017. The green section shows the CRFB’s projection of various outcomes of US debt under Trump’s agenda, ranging from 129% to 161% of GDP in 2035.
So why would a worsening budget deficit outlook cause the market to drive up long-term borrowing costs? Well, it has to do with the perceived credit worthiness of the borrower. As a lender, you would prefer to lend to someone, or some country, that has less debt than more debt, all things being equal, right? It’s just less risky to lend to someone less in debt than more in debt. But if that highly indebted borrower offers to pay more interest to compensate you for the additional risk you bare with them over the less indebted borrower, you may reconsider. That is what appears to be happening now — the market is demanding an annual interest rate of 4.77% (as of 10 January) to lend to the US government for a 10-year period (i.e. the 10-year Treasury). Back in mid-September, when it was much less clear who would be inaugurated on January 20th, the market was only demanding 3.62% in annual interest.
A higher rate on the 10-year Treasury is not just a headwind for the US government — it is also a headwind for individuals and companies borrowing in US dollars as their borrowing rates are indexed off of the “risk-free” government borrowing rate. For example, when the yield on the 10-year Treasury spiked 115 basis points since mid-September, the average 30-year home mortgage increased 85 basis points to nearly 7%. Higher interest rates hurt the economy and US company earnings and growth prospects.
Source: St. Louis Fed, AlphaGlider
Of course one must always take politicians’ campaign promises with a grain of salt, and this is especially the case with Trump who has been shown to reverse course frequently and without warning. Once back in office, it would not be surprising to see Trump roll back some of his agenda under pressure from consumers, businesses, and investors in the face of higher inflation and falling stock and bond prices. We actually suspect that this is the likely scenario assumed by many in the market. Trump’s agenda also faces the challenge of getting enacted in the first place. Trump’s tax cuts must get through the House of Representatives where Republicans hold a slim majority and have a sizable number of its members whose primary motivation is to prevent higher budget deficits. And the agenda items that Trump can push through with executive orders, like tariffs, deregulation, and mass deportations, can be delayed or killed by court challenges from the political left.
Heading overseas, we see that it is not just the United States experiencing seismic changes in its politics. After snap elections last summer which failed to deliver a parliamentary majority, French President Emmanuel Macron is struggling to reign in a budget deficit that exceeds 6% of GDP (but less than the US’s FY24 budget deficit of 6.4%). Over in Germany, where its deficits are in check but its economy suffered its second consecutive year of contraction, Chancellor Olaf Scholz lost a vote of confidence in parliament in December — paving the way for early elections in February. Earlier this month, Canada’s Prime Minister Justin Trudeau announced he would step down as leader of his party ahead of the national election expected to take place in the spring. Canada is experiencing a sluggish economy and a rising public groundswell against its open immigration policies. Like in the US, the politics of all three of these countries is moving to the right.
South Korea is also undergoing significant political turmoil at the moment, although this appears to be less economic in nature and more to do with the divisive nature of its President, Yoon Suk Yeol. Locked in a political standoff with the opposition and his approval ratings low, Yoon surprised the world by declaring martial law in early December. Resistance to Yoon was swift and hard, forcing him to quickly rescind his call. He was impeached 11 days later and eventually arrested after a long standoff with the police.
On a more positive note, there were several encouraging developments in the Middle East. Israel reached a ceasefire agreement with Hezbollah in late November, and another one with Hamas this past week. But more consequential was the fall of the Assad regime to Sunni rebels in Syria, dealing major blows to Iranian and Russian influence across the region.
PERFORMANCE DISCUSSION
Fourth Quarter
AlphaGlider strategies have historically outperformed on a relative basis in down markets, but this was not the case in the fourth quarter. The return of Trump and his agenda of lower corporate taxes, higher tariffs, and higher budget deficits, supercharged US large-cap growth equities to which we were underweight, and slammed foreign equities to which we were overweight. AlphaGlider strategies also suffered from their slight overweighting to fixed income which fell in fear of Trump’s inflationary policies.
There were some bright areas for AlphaGlider strategies during the quarter, most notably in our fixed income investments. Whereas our fixed income benchmark, the Bloomberg US Aggregate Bond Index, was down over 3% during the quarter, we were heavily weighted toward shorter duration fixed income investments which were down less than 1%. Our developed foreign fixed income investments and ultra short-term Treasuries managed to eke out positive returns. And while both emerging and developed foreign equities were down in the high single-digits this quarter, our Singaporean fund was up 1%.
There was little difference between the performances of our ESG and Core strategies during the quarter, despite clean energy stocks suffering mightily in the face of Trump’s election victory.
Last 12 Months
AlphaGlider strategies returned attractive absolute returns in 2024, yet they fell approximately 25% short of their respective benchmarks’ performance. As in the most recent quarter, our strategies’ underweighting of US large-cap growth equities and overweighting of international equities led to most of this relative underperformance. One international investment that bucked this trend was our Singaporean fund which was up 22.5%.
Our fixed income investments had a fairly neutral impact on our strategies’ relative performance. We were slightly overweight fixed income, which hurt performance, but the short average duration of our fixed income investments helped.
As in the fourth quarter, our ESG strategies performed similarly to our Core strategies over the duration of 2024.
LOOKING FORWARD
During the quarter we made some changes throughout all AlphaGlider strategies to reflect the new reality of the incoming Trump administration and Republican control of the House and Senate. This reality likely includes widespread tariffs applied on many if not all of the US's trading partners, and retaliatory tariffs against the US in return. It likely includes lower tax rates on US companies, especially those which do not have manufacturing facilities overseas. And it may include fewer regulations and anti-trust enforcement on US companies.
Early indications of Trump 2.0 appear to be much like Trump 1.0, but with more aggressiveness and more executional competence. With the benefit of having watched Trump 1.0 play out, we foresee Trump 2.0 causing, relative to the Biden status-quo, larger budget deficits, slightly faster economic growth, inflation that persistently runs above the Fed's 2% target, and a stronger for longer US dollar (faster US growth, higher US inflation and rates, more global uncertainty and geopolitical tensions all signal a stronger US dollar). We think that US corporate profits will benefit from lower taxes and lower regulation, but will be hurt by higher borrowing costs and retaliatory tariffs. We expect that some US companies will come out ahead from Trump 2.0, and some that will suffer.
With all this in mind, we are marginally increasing our overall exposure to equities, but will remain slightly (3-5%) underweight equities relative to our benchmarks. Despite their high valuations, we are increasing our exposure to US equities by approximately 20%, but are still significantly (approximately 20%) underweight them relative to our benchmarks. We are expanding the position sizes of all of our current US equity funds, but none more than mid-cap US companies which we think will be less exposed to damaging retaliatory tariffs and a stronger dollar than large-cap US companies, and less impacted by higher interest rates than small-cap US companies. Additionally, US mid-caps are more attractively valued than the overall US equity market. According to JP Morgan Asset Management, the ratio of price to 12-month forward earnings for US mid-caps is close to its 30-year historical average (60th percentile), while this ratio for the S&P 500 is near its all-time high over the last 35 years (95th percentile).
We are reducing our international exposure by 10-15%, by eliminating exposure to international real estate which we expect will struggle if the US dollar appreciates, eliminating exposure to Singaporean equities which are heavily exposed to global trade and China and had a strong 2024 (+22.5% total return). We also trimming our developed Asia-Pacific equities which we had been especially overweight in our strategies. We find valuations and expectations low to fair for both developed and emerging markets, and thus retain significant overweight positions in them relative to our benchmarks: ~40% overweight developed equity markets and ~15% overweight emerging equity markets.
With our overall exposure to equities increasing, we are decreasing our strategies' exposure to fixed income. However, our strategies remain slightly (0-5%) overweight fixed income relative to their benchmarks. We are doing this by trimming short-term Treasuries in our more conservative strategies, and short-term corporate bonds and international bonds in our more aggressive strategies. We are increasing exposure to mortgage backed securities, mainly to shrink the significant underweighting of them relative to their benchmarks—but we still remain 35-40% underweight this fixed income category due to our large government bond exposure. What is not changing is our skew toward shorter duration bonds and inflation-protected securities given our fear that inflation, and in turn rates, will run hotter than the market currently expects.
NOTES & DISCLOSURES
1This material represents an assessment of the market and economic environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. Forward-looking statements are subject to certain risks and uncertainties. Actual results, performance or achievements may differ materially from those expressed or implied. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete, and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.
2Mutual funds, exchange-traded funds and exchange-traded notes are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained directly from the Fund Company or your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.
3Alternative investments, including hedge funds, commodities and managed futures involve a high degree of risk, often engage in leveraging and other speculative investments practices that may increase risk of investment loss, can be highly illiquid, are not required to provide periodic pricing or valuation information to investors, may involve complex tax structures and delays in distributing important tax information, are subject to the same regulatory requirements as mutual funds, often charge higher fees which may offset any trading profits, and in many cases the underlying investments are not transparent and are known only to the investment manager. The performance of alternative investments including hedge funds and managed futures can be volatile. Often, hedge funds or managed futures account managers have total trading authority over their funds or accounts; the use of a single advisor applying generally similar trading programs could mean lack of diversification and, consequently, higher risk. There is often no secondary market for an investor’s interest in alternative investments, including hedge funds and managed futures and none is expected to develop. There may be restrictions on transferring interests in any alternative investment. Alternative investment products including hedge funds and managed futures often execute a substantial portion of their trades on non-US exchanges. Investing in foreign markets may entail risks that differ from those associated with investments in the US markets. Additionally, alternative investments including hedge funds and managed futures often entail commodity trading which can involve substantial risk of loss.
4Rebalancing can entail transaction costs and tax consequences that should be considered when determining a rebalancing strategy.
^Indices are unmanaged and investors cannot invest directly in an index. The performance of indices do not account for any fees, commissions or other expenses that would be incurred.
aThe Standard & Poor's 500 (S&P 500) Index is a free float-adjusted market capitalization weighted index that is designed to measure large cap US equities. The index includes 500 leading companies and captures approximately 80% coverage of available market capitalization in the US equity markets.
bMSCI Europe, Australasia and Far East (EAFE) Index is a free float-adjusted market capitalization weighted index that is designed to measure the investable universe of developed market equities outside of the US.
cMSCI Emerging Markets (EM) Index is a free float-adjusted market capitalization weighted index that is designed to measure large and mid-cap equity market performance in the global Emerging Markets.
dMSCI All-Country World (ACWI) Investable Market Index (IMI) is a free float-adjusted market capitalization weighted index that is designed to measure the investable universe of global equity markets.
eThe Bloomberg Barclays US Aggregate Bond Index is a market capitalization weighted index that is designed to track most investment grade bonds traded in the United States. The index includes Treasury securities, government agency bonds, mortgage-backed bonds, corporate bonds and a small amount of foreign bonds traded in the United States. Municipal bonds and Treasury Inflation-Protected Securities (TIPS) are excluded due to tax treatment issues.
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