Q4 2024

As you will see, the stock market finished on a strong note, capping another very good year. Fourth quarter performance was a bit of a reversion to previous trends. A few larger technology stocks produced the best performance, nonetheless the overall tone remained good.

Stock markets were supported by a shift in interest rate policy at the Fed. The Fed cut rates three times in late 2024 and indicated they would be cutting rates two more times in 2025. More on this in a moment.

In case you missed it, we also had an election. Since the election, we’ve fielded quite a few calls inquiring about our thoughts on its impact. We will tell you this: what we’ve come to believe is the electoral success of one party or the other has little consequential impact on the markets over the long term. Simply winning an election does not mean permanent policy changes are at hand; no matter what was promised in the campaign.

The legislative process is cumbersome and prone to favor the status quo. Because of this, the legislative and executive branches have settled on less democratic processes for implementing policy. The consequence is that their policies are temporary. Permanent policy changes tend to be consumed by the legislative process. There always seems to be just enough opposition to kill most bills.

The Democrats are clearly more unified than Republicans in the House. Rarely do they have dissenting votes; the Republicans are rarely unified. However, without 60 votes in the Senate, only budgetary bills (subject to reconciliation) can pass both houses.

One consequence is that we cannot get permanent Federal tax laws passed. To avoid filibusters in the Senate and conform with the Byrd Rules, tax laws only get passed, if they have an expiration. Current Federal tax laws passed in 2017 are set to expire this year. All eyes will be trained on that debate.

In the executive branch, most recent Presidents have bypassed the legislative process and implemented policies through the liberal use of Executive Orders. Executive Orders, however, are not permanent and tend to last only until the next President is sworn in.

If you asked us what we think is most consequential for the market right now, we’d say (knowing full well you’ve heard this enough) it’s the Fed’s interest rate cuts.

 We’re not going to repeat our arguments against recent rate cuts, as we discussed them thoroughly in our last letter. We want to highlight the bond market’s response to the cuts; which find it quite interesting. Let’s roll back to December 31, 2021. That’s a good start date as it’s just before the Fed started raising interest rates.

On December 31, 2021, the pandemic was pretty much behind us. We were starting to learn that you can’t shut down the world’s economy and have it restarted smoothly. Ships were backed up at the docks in Long Beach, supply chains were short of products, and delivery times were extended. Inflation was starting to pick up. In the year prior (2020), reported CPI (consumer inflation) was running at 1.70%. By December 2021, CPI was up to 3.5% (on its way to 6.5% in December 2022).

In December 2021, you could get a mortgage for around 3%. Why? Because the Federal Reserve, in an effort to “stimulate” economic activity, was keeping interest rates low.

Interest rates on December 31, 2021, were: 3-month T-Bill rates at 0%! A 30-year Treasury bond paid interest of 1.70%. That’s where we started.

To combat inflation, the Fed started raising interest rates in 2022. They continued to raise rates until September of 2024. On September 15th, 2024, just before the rate cuts started, interest rates were: 3-month T-Bill 5.08%, 30-year Treasury Bond 3.98%.

Next, let’s move to year-end. On December 31st, 2024, here’s where interest rates were (after three rate cuts): 3-month T-Bill 4.28%, 30-year Treasury Bond 4.78%.

Notice that despite the Fed cutting short-term rates, long-term interest rates have gone up. This is why mortgage rates are not falling. The bond market is not going along with the Fed. Interest rates must ultimately reflect the cost of money; inflation matters. What we’re seeing is a yellow flag, the market is not confident inflation is behind us. Hopefully, this has the Fed reconsidering future rate cuts.

For now, conditions in the stock market seem favorable. We all know there’s a lot of excitement surrounding AI, which is expressed in the extended valuations for some companies. I don’t find valuations extended across the whole stock market.

We know there is concern tariffs could undermine economic growth. For now, we’re assuming this is a negotiation tactic. That will bear watching.

Enjoy your winter, and good health to you all!