Insights
Quarterly Commentary
4Q 2024
The idea of American exceptionalism goes back to the Revolutionary War when the colonists declared their commitment to liberty and self-determination. Since then, the term has been used to describe many different views on America’s special place in the world. In recent decades, the concept has been extended to the financial arena. With wide disparities in global stock market performance again in 2024, American exceptionalism is getting a lot of attention in the press these days.
Last year among all major countries, the United States had the strongest economy as well as the biggest, fastest growing, and most profitable businesses. For investors who maintain diversification outside of the US markets, the performance divergence was hard to ignore. In US dollars, developed international stocks returned less than 4% while large cap US stocks were up more than 23%. The primary explanation is the belief that large tech companies will continue to grow at a faster rate than other US or foreign businesses, perhaps indefinitely and without regard for economic conditions.
After the US election, anticipation of deregulation and tax cuts helped drive US stocks up by 5%. Foreign stocks lost 5% (in dollar terms) amid concerns around the impact of new policies, tariffs in particular. Enthusiasm over Trump 2.0 was dampened at year end as intermediate and long-term interest rates trended higher. This confounded those who assumed that long rates would follow short rates lower. The Fed cut three times, lowering their target from 5.25% in September to 4.25% in December, yet the yield on the 10-year Treasury bond rose from 3.6% to 4.6% over the same time frame.
This yield curve steepening (long rates higher than short rates) is notable – the curve had been inverted since July 2022. The spread between 10-year and two-year yields plunged to minus 1% in 2023 when inflation was raging. It ended 2024 at positive 0.3%. The average spread (over fifty years) is 0.8%. Moving towards “normal” is a positive for banks and financial instruments that borrow “short” and invest/lend “long.” But it is not great news for home buyers or businesses who typically take on long-term debt.
Looking ahead
There is widespread agreement that the US economy will continue to outperform in 2025. For stocks to follow suit, it would likely mean the “Mag 7” will need to push even higher. This group – Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, and Tesla – comprises over 30% of the S&P 500 and accounted for well over half of its gains in 2024! It is interesting to note that only one of the top 10 stocks from the S&P 500 in the year 2000 remains – Microsoft.
Such optimism is especially notable as stocks have risen five out of the last six years. While valuations remain reasonable in many corners of the market, there are clearly areas of exuberance – AI, crypto, Tesla, etc. We see the potential for both large positive and negative surprises. On the one hand, should Trump’s pro-growth agenda not prove inflationary, lower interest rates (across the yield curve), an uptick in sentiment, and reinvigorated capital markets could broaden the market rally and send stocks to new highs. On the other hand, with almost all strategists expecting continued economic strength and for stocks to continue rising, any negative surprises could reveal a significant air pocket, especially for the market’s darlings.
The new administration’s policies and the bond market will play important roles in the year to come. How tariffs, tax cuts, deregulation, curbed immigration and/or deportation, budget cuts, and other policies will be implemented, and to what degree they may prove to be inflationary or deflationary, remains to be determined. The Fed has adopted a wait-and-see approach and will probably slow-walk interest rate cuts from here.
The bond market is often given credit for anticipating the future better than stocks. What is it telling us now? We don’t know for certain – but if we must guess it would be fear of reaccelerating inflation. Possible causes include continuing budget deficits, less confidence in new technology’s productivity boost, rising labor or material costs, or the end of the “peace dividend” – higher military spending in the US and elsewhere. These all merit monitoring.
As much as American exceptionalism (in the markets!) appears to be a trend without end, we believe it is prudent to question all assumptions, especially those that are widely held. We see a wide range of possible outcomes in 2025. That doesn’t mean there is reason to panic, but that it is a good time to pause and ensure investments are properly positioned for your situation. We are here to help and happy to talk whenever it is convenient for you.
