Investment Management - Fourth Quarter 2024

Sleigh Bell and Surprises

Another holiday season has passed. While the time between Thanksgiving and New Year’s traditionally meant gathering with family and friends in a spirit of reflection, thankfulness, and celebration, today’s narrative differs dramatically. One might easily mistake consumption, overindulgence, and ugly sweaters as the season’s primary focus. Comedian Nate Bargatze highlighted this evolution in his Nashville Christmas special, playing an angel who humorously pointed out how far we have strayed from the season’s original meaning. He observed that Christmas celebrations shifted from commemorating a birth in a desert manger to singing about snow and winter festivities. The punchline: we now worship an almighty being who separates the righteous from the wicked – Santa Claus.ⁱ

Like those righteous kids expecting gifts, investors are usually giddy during the holiday season. Since 1950, the seven trading days after Christmas are known for an anomaly dubbed the “Santa Claus rally.”ⁱⁱ During that period, the S&P 500 has finished positive 76.6% of the time, far more than the average seven- day period. But this year, as investors dreamed of reindeer and sleighs, the Federal Reserve (the Fed) delivered a grinch-like message regarding inflation, causing a material decline in prices of longer-term treasuries, and correspondingly, a surge higher in yields through year-end.

The unexpected spike of 10-year Treasury yields created selling pressure in equity markets. Though major indices declined in December, overall, the fourth quarter was positive for most domestic markets. The total return for the S&P 500 index was 2.41%. The S&P MidCap 400 rose 0.34% while the SmallCap 600 fell 0.58%. International equities continue to underperform their domestic counterparts, falling 8.11% during the quarter, due largely to a rally in the U.S. dollar relative to other major currencies.

Performanceⁱⁱⁱ for various indices for the three-month (not annualized), one-year, three-year, and five-year periods appears below:

Bond Indices

Equity Indices

Stocks are currently in a strong bull market. For perspective, since the closing low in October 2022, price appreciation of the S&P 500 index was 64.4%. While significant, it is not unusual given the substantial price declines seen in 2022 across several asset classes. For the second year in a row, the S&P 500 achieved a total return of greater than 25%. The last time the large cap index had back-to-back 20% returns was 1998 and 1999.^iv Since then, there has been considerable reflection on how markets fared over the next few years, but we believe this time is different. While valuations are elevated, with the forward price-to- earnings (PE) ratio of the S&P 500 increasing from a low of 16.5x in 2022 to 21.5x at the end of 2024, we are far from the late 1990’s days of irrational exuberance, when the S&P 500 forward PE ratio hit 29.7x. Higher multiples limit future return potential, since further expansion becomes less likely. Offsetting higher valuations, S&P 500 earnings-per-share estimates for 2025 are forecast to accelerate year-over-year growth compared to last year.

Other major criticisms of the current market rally center on structural issues. One key concern is the disparity of growth created by higher interest rates. Cyclical industries and those dependent on financing have generally struggled in a quagmire for the past four years. Meanwhile, sectors less tethered to the broader economy – such as cloud services, data centers, software, semiconductors, and companies with GLP-1 drug franchises — have largely thrived. With growth concentrated in such a small segment of the overall economy, investors have crowded into these names, exacerbating concerns around valuation. This is particularly true for companies benefiting from secular growth themes, especially the so-called “Magnificent Seven.” These mega-cap companies, already carrying significant weight in major indices due to their size, have been driving earnings growth and valuations for the S&P 500. According to JP Morgan, those seven stocks accounted for 55% of the index’s total return last year.^v Echoing past manias, at year-end, the market-cap of the index’s top ten stocks was 38.7% of the index. During the internet bubble, the top 10 stocks were never more than 28%.

Overall, the U.S. economy demonstrated robust growth, with real Gross Domestic Product (GDP) increasing at an annual rate of 3.1% in the third quarter.^vi Consumer spending, a significant driver of this economic expansion, grew 3.7%, defying forecasts of wide-spread deceleration. While labor markets softened as the Fed raised rates, they remained resilient, and the absence of sustained increases in new jobless claims helped maintain consumer confidence and spending. Expanded government spending further aided in bolstering growth, helping to offset a decline in residential fixed investment.

With the domestic economy growing faster than most economists’ forecasts, stalled disinflation signals potential concerns. According to the U.S. Bureau of Labor Statistics’ November Consumer Price Index, core-CPI (excluding food and energy) rose 2.7% for the trailing twelve months, up 0.1% from October’s data. To assess persistent inflation trends, the Fed monitors “sticky” inflation categories —components of goods and services with less frequent price changes, compared to more volatile components like gasoline. Significant components of CPI included in the “sticky-price items” include housing, medical services, and education.^vii Adding to these concerns, inflation expectations appear to be shifting: the Federal Reserve Bank of St. Louis’s 5-year expectations chart has troughed and shows signs of trending higher, suggesting that embers from the previous inflation battle could reignite.

Fred 5-year inflation expectations. 1/13/25 of 2.5% (High 3/25/22 – 3.59% / Low 3/19/2020 – 0.14%)^viii

The benchmark 10-year Treasury yield has showed remarkable consistency at 4.2% in both October 2022 and October 2024, but experienced significant fluctuations between these points. The yield dropped to 3.25% in March 2023 due to the regional banking crisis, and almost hit 5% in October 2023. A notable shift occurred during the fourth quarter, when Citi’s Economic Surprise Index troughed and began rising after August’s volatility, alongside presidential candidates’ promises of increased deficit spending.^ix Whether the rationale was stronger growth, rising inflation, or increased costs of servicing the U.S. debt load, bond vigilantes (investors) began to sell longer-term treasuries, pushing the 10-year Treasury yield from 3.6% to 4.57% by year-end. While yields remain within an established range, a break above 5% will likely have material implications for both stock and bond investors.

Yields on the 10-year Treasury, while susceptible to short-term supply and demand imbalances, should roughly equal real U.S. GDP growth and inflation. Upward revisions of expectations for both are likely behind the recent trend higher. When the 10-year Treasury yield rises, relative to short-term rates, the slope of the treasury yield curve steepens. Bond investors typically associate this steepening with optimism over future economic growth. The implications of an improving outlook to monetary policy were evident during Fed Chairman Jerome Powell’s press conference following last month’s 25 basis point rate cut. “The risks around the inflation forecast were seen as tilted to the upside, as core inflation had not come down as much as expected in 2024 and the effects of trade policy changes could be larger than the staff had assumed.”^x Due to increased concern over price stability, the Fed projected a more gradual approach to easing monetary policy, meaning fewer rate cuts. The more hawkish stance on inflation appears to have triggered increased bond selling through year-end.

There are many changing dynamics occurring, and the new administration was just sworn in. During our January Investment Committee meeting, we assessed the current environment and discussed potential changes to both our top-down asset class exposure, along with our thematic and tactical equity positions. It is possible that institutional rebalancing could weigh on equities throughout 2025. If fully funded, pension plans that are overweight equity exposure could rebalance towards bonds now that real yields have rebounded to pre-Global Financial Crisis levels. For fixed income allocations, despite the volatility in rates, we have been able to buy bonds at attractive yields. We also continued to sell older, lower coupon bonds to realize a tax loss and replace them with higher yielding bonds, where appropriate.

As a new administration takes office, many clients are asking us about potential changes in policy, and what impact those changes might have on their financial situations. In particular, many provisions of the 2017 Tax Cuts and Jobs Act (TCJA) will begin to sunset at the end of 2025. President Trump has proposed extending, and in some cases, enhancing many of these provisions. These include lowering individual and corporate tax rates, maintaining the current lifetime gift and estate tax exemption amount at $13.99 million per taxpayer, eliminating the $10,000 limit on state and local tax deductions, and pro-business measures related to Qualified Business Income (QBI) deductions and bonus depreciation. While nothing is certain until new legislation is enacted by Congress, we are following developments closely and will be sure to communicate any changes, if and when they occur.

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We would like to introduce the newest member of our client service team, Debra Kosch. Debra joined West Financial as a client service associate in November 2024. Debra earned a Bachelor of Arts degree in International Studies from George Mason University, and a Master of Philosophy in Clinical Psychology degree from George Washington University. She holds a Society for Human Resource Management Certified Professional certification and is a great addition to our team here at West. Welcome Debra!

Congratulations to Brian Horan, Abby Just, Matt Cohen, Kirstie Martinez, Brian Mackin, Tanya Carson, Laura Nash, Jonathan Stolz, and Dan Trosch for being named as Five Star Wealth Managers by Five Star Professional in November 2024.^xi 

In December, West Financial Services was named as one of the Best RIAs to Work for in 2024 by Financial Planning Magazine.^xii Our commitment to excellent service extends to not only our clients, but also our employees!

We have provided performance numbers for the quarter, one-year, three-year and five-year periods, where appropriate. The custodian where your account is held will be sending Form 1099-DIV (dividends) and Form 1099-INT (interest) information to you directly. Also, the Form 1099-B will provide a record of realized gains and/or losses in taxable account(s) as well as any management fees paid directly from your brokerage account(s). Please contact us if you have questions or need additional information for the preparation of your tax returns.

In addition to your statements, your packet will include any restrictions that you have placed on your account. Please review these and contact us should there be any changes. Also, now would be a good time to review your asset allocation and risk tolerance. If you have had any changes to your income, marital status, state of residence, tax bracket, etc., please be sure to let us know.

Thank you for your continued confidence in West Financial, and please do not hesitate to refer friends, family, or co-workers who you feel may benefit from our services.

Brian L. Mackin, CFP®	Glenn Robinson, CFA
President	Chief Investment Officer

ⁱ https://www.cbs.com/shows/nate-bargatzes-nashville-christmas/ 

ⁱⁱ https://en.wikipedia.org/wiki/Santa_Claus_rally 

ⁱⁱⁱ Each of the S&P 500 Index, the S&P 400 Index, the S&P 600 Index, the MSCI EAFE Index, the ICE BofA 1-5 Year Index, the ICE BofA 1-10 Year Index, the ICE BofA 1-12 Year Municipal Bond Index, the Dow Jones Industrial Average, and the NASDAQ Composite (each, an “Index”) is an unmanaged index of securities that is used as a general measure of market performance. The performance of an Index is not reflective of the performance of any specific investment. Each Index comparison is provided for informational purposes only and should not be used as the basis for making an investment decision. Further, the performance of your account and each Index may not be comparable. There may be significant differences between the characteristics of your account and each Index, including, but not limited to, risk profile, liquidity, volatility and asset comparison. The performance shown for each Index reflects no adjustment for client additions or withdrawals, and no deduction for fees or expenses. Accordingly, comparisons against the Index may be of limited use. Investments cannot be made directly into an Index. 

^iv https://www.slickcharts.com/sp500/returns 

^v JP Morgan US Guide to the Markets: 1Q2025, Pg. 12, As of December 31, 2024. 

^vi https://www.bea.gov/nws/2024/gross-domestic-product-third-estimate-corporate-profits-revised-estimate-and-gdp-1 

^vii https://www.atlantafed.org/-/media/documents/research/inflationproject/stickyprice/sticky-price-cpi-supplemental-reading.pdf 

^viii https://fred.stlouisfed.org/series/T5YIE 

^ix https://cbonds.com/indexes/99130/ 

^x https://www.federalreserve.gov/monetarypolicy/files/fomcminutes20241218.pdf 

^xi Five Star Wealth Manager Award program, managed by Five Star Professional (FSP), conducts market-specific research throughout the U.S. and Canada to select reputable, specialized, and honest service professionals. This award is for the time period 1/9/24 through 8/9/24.  Award candidates that satisfied 1- objective criteria were named 2024 Five Star Wealth Managers. Required Eligibility Criteria: 1. Credentialed as a registered investment adviser (RIA) or a registered investment adviser representative; 2. Actively licensed as a RIA or as a principal of a registered investment adviser firm for a minimum of 5 years; 3. Favorable regulatory and complaint history review; 4. Fulfilled their firm review based on internal standards; 5. Accepting new clients. Additional Evaluation Criteria: 1. One-year client retention rate; 2. Five-year client retention rate; 3. Non-institutional discretionary and/or non-discretionary client assets administered; 4. Number of client households served; and 5. Education and professional designations. Neither WFS nor any of its employees paid FSP a fee to be considered or placed on the final list of Five Star Wealth Managers. 

^xii In order for firms to be recognized as Best RIAs to Work by Financial Planning magazine, Financial Planning magazine and Best Companies Group invite firms to complete a survey, which asks firms to explain their various offerings and practices. Any firm recognized must satisfy the following criteria: 1. Be registered as an investment adviser with the SEC; 2. Have a facility in the United States; 3. Have a minimum of ten employees working in the United States; and 4. Be in business for a minimum of one year. Financing Planning magazine then evaluates each nominated firm’s workplace policies, practices, philosophy, systems and demographics. Additionally, employees are invited to complete a survey to measure the employee experience at the firm. Once both portions of the assessment are complete, the combined scores determine the final ranking and whether the firm will be named one of the Best RIAs to Work. Firms do not pay a fee to be considered or placed on the final list of Best RIAs to Work For. The only cost is to allow participating firms to view the employee feedback reports. 

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This information is intended to be educational in nature, and not as a recommendation of any particular strategy, approach, product or concept. These materials are not intended as any form of substitute for individualized investment advice. The discussion is general in nature, and therefore not intended to recommend or endorse any asset class, security, or technical aspect of any security for the purpose of allowing a reader to use the approach on their own. Certain information contained herein was derived from third party sources as indicated. While the information presented herein is believed to be reliable, no representation or warranty is made concerning the accuracy of any information presented. WFS has not and will not independently verify this information. Where such sources include opinions and projections, such opinions and projections should be ascribed only to the applicable third party source and not to WFS.

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