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“Every past market decline looks like an opportunity; every future decline looks like a risk.”

—Morgan Housel

Markets Obsessed with DC

The dominant story for Q4 was the election results.  There are many possible implications, but it’s hard to know their effects on policy until the new occupants take charge.

Also coming out of DC is the more present driver of investor flows…interest rates. We started October expecting a series of cuts through 2025 but ended December looking at maybe just one more to go along with the three that have already taken place. If you’re watching carefully, you may have noticed that these decreases to short-term interest rates have actually caused longer-term rates (like mortgages) to go higher. More on that later, first a recap of recent market leaders and laggards.

Q4 Market

Stocks were weak in October, then had a huge election-inspired rally into December that ultimately fizzled out. The old playbook from the first half of the year took charge again:

  • Growth > Value
  • Large > Small
  • US > Foreign

Source: Morningstar

Recent history has certainly blessed U.S. investors, but leadership ebbs and flows, with diversification proving valuable in periods when leadership flips:

Q4 Actions

Conditions didn’t warrant any portfolio changes as we continued to survey the market environment. Holdings performed as expected, as we monitored rates and earnings and refrained from making any major moves related to the election.

In general, we’ll be closely watching things unfold, and if anything indicates a new sustained risk or opportunity, we’ll adjust our positioning accordingly.

Our models have invested in Bitcoin for several years now.  It’s a very small position, but the risk/reward opportunity and diversification benefits continue to reward patient and disciplined investors.

Two charts on the investment rationale:

Source: Blackrock

Risks and Outlook

With U.S. consumers (and businesses) generally in good shape, there are three areas on our minds as we look to 2025:

  • Interest Rates
  • Policy Changes
  • Broader

Interest Rates

This has been the biggest source of investor confusion. If the Fed is lowering interest rates, why are rates on mortgages, car loans, etc., rising?

It’s important to note that Fed policy dictates short-term rates only, essentially the overnight lending rate amongst banks. While that has historically carried through to longer-term rates, in this case, it most definitely has not:

There are several reasons this is happening, a few as follows:

  • Lower rates are designed to stimulate activity, creating higher economic growth, which is ultimately an input to higher long-term rates. It’s just happening faster this time.
  • Higher economic growth can trigger inflation, a lingering concern after the damaging impact of the 2021-22 cycle.
  • Government spending (and the resulting debt) has awoken the once-famous “bond vigilantes”, who are now demanding higher compensation for the possibility that too much spending will erode future purchasing power.

Rates certainly feel high compared to the historic lows post-COVID, but looking objectively, we’re just settling back into the rate environment in place throughout the 1990s and 2000s.

It is painful for first-time home buyers, realtors, and mortgage companies, but the economy and markets both show they can handle this “new normal” regardless of what the Fed decides to do. Our defensive sleeve was rebuilt for this a few years back, and we remain comfortable with its positioning.

Policy Changes

An obvious priority for the new administration is tariffs. While some changes to trading policies can be as simple as an executive order (China), others involve agreements with allies and will be trickier to navigate. It seems like we’ll quickly find out what the new administration has in mind; to date, tariffs have been mostly low-impact, and obviously, there is talk of significant change there.

Taxes are another issue. 2025 has been the looming endpoint for the 2017 Tax Cut and Job Act, and there will be an effort to extend these changes and attempt to make them permanent. This graphic would have looked different if the laws expired, but a baseline assumption is a continuation of current policies. A few examples here:

Important to markets, but hard to pinpoint and likely more important to individual client situations. We’ll watch closely and look for ways to optimize your specific plan.

Beyond AI and Big Tech

“When something is on the pedestal of popularity, the risk of a decline is high. When people assume—and price in—an expectation that things can only get better, the damage done by negative surprises is profound.”

Howard Marks

As you might suspect, Marks is referring to the hype surrounding artificial intelligence (AI) stocks. He doesn’t deny the benefits it may bring or the investments being made in AI. He’s simply noting that investors often herd into the story of the day and that doing so can create expectations that run into the law of large numbers. A picture of just how dominant the largest companies have become in just a few years:

And while these companies have been superior businesses, their stocks have been rewarded with significant price premiums over the rest of the market:

For the other thousands of stocks, being cheaper hasn’t been enough to restore historical valuation comparisons. We hold positions in smaller, less glamorous areas of the market because these cycles run in and out of favor. However, the true catalyst would be better earnings growth. As shown below, smaller companies like those found in the S&P 600, may finally deliver on that:

Source: Strategas as of 01.13.2024

Conclusion

We’re confident in the positioning of both our growth and defensive sleeves and the balance between the two. We’ll continue monitoring the policy environment and loop you in on broad themes and your specific opportunities. As always, we appreciate your trust and welcome your feedback.

 

 

 

 

 

 

 

*The views expressed represent the opinions of Compass Ion Advisors, LLC, as of the date noted and are subject to change. These views are not intended as a forecast, a guarantee of future results, investment recommendation, or an offer to buy or sell any securities. The information provided is of a general nature and should not be construed as investment advice or to provide any investment, tax, financial, or legal advice or service to any person. The information contained has been compiled from sources deemed reliable, yet accuracy is not guaranteed.

Additional information, including management fees and expenses, is provided on our Form ADV Part 2 available upon request or at the SEC’s Investment Adviser Public Disclosure website at https://adviserinfo.sec.gov/firm/summary/166418. Past performance is not a guarantee of future results.