One of my favorite parts about meeting with clients is the opportunity to gather direct feedback from you on how we can continue to enhance our client experience. A piece of feedback that has been recurring and valuable is the desire for us to articulate our market outlook and portfolio positioning in a concise summary. It was recently asked: What are the three to five most important things we would like you to know about how we are viewing the markets and managing client assets? Below, we share our First Quarter 2025 Investment Commentary in a new and improved format (please forgive us for including a sixth bulletpoint):
- 2024 Recap: Equity markets generated exceptionally strong returns, driven by optimism surrounding a select group of AI-themed technology stocks. Fixed income returns were modestly positive. While short-term interest rates declined as the Fed began to lower the Fed Funds rate, intermediate and long-term rates rose as the U.S. economy proved resilient and inflation fell but remained above the Fed’s target. In the category of public alternative investments, gold outperformed both equities and fixed income, aided by nagging inflationary pressures and mounting political/geopolitical uncertainty.
- Economic Outlook: We are seeing signs that the momentum of the U.S. economy is slowing. Excess savings on consumer balances sheets appear depleted; credit card and auto loan delinquency rates are rising; leading indicators in the labor market are softening; housing activity is declining; and commercial real estate remains under pressure. Our research suggests that the election results increase the likelihood that the momentum of the economy could slow. While the potential extension of tax cuts and deregulation in certain industries should support corporate earnings, the possibility of tariffs and a shrinking labor supply due to immigration reform could be inflationary and represent a larger drag on economic growth.
- Asset Allocation: We are managing equity allocations below long-term targets in client portfolios given deteriorating risk-reward characteristics. The excess return investors should expect to receive for taking excess risk in the equity markets (this is known as the equity risk premium) has declined due to a combination of accelerating earnings growth estimates, expanding valuation multiples, and higher interest rates. In other words, fixed income has become relatively more attractive.
- Equities: We are holding a basket of high-quality, large U.S. businesses as the core of our equity exposure. Our strategy is concentrated, yet sufficiently diversified with less than two dozen businesses. Constituents include several of the tech giants, including Google and Microsoft, that have propelled the S&P 500 higher and grown to represent an outsized portion of the index. However, we are choosing to hold less exposure in order to allow more capacity to own other high-quality businesses in other critical sectors such as financials, health care, and consumer staples. We estimate that in aggregate, our portfolio possesses more favorable growth, income, and fundamental stability characteristics than the S&P while trading at a lower valuation multiple. History suggests that these attributes should generate superior results over the long run.
- Fixed Income: We are emphasizing high-quality short and intermediate-term bonds. The path of inflation and interest rates feels particularly unclear at this point in time, and we do not believe investors are being adequately compensated for taking maturity risk in long-dated bonds.
- Alternative Investments: We are holding a position in gold and expect it should continue to add value if inflationary pressures and political/geopolitical uncertainty remain elevated. Lastly but equally important, for clients who have the ability and willingness to tolerate the illiquidity characteristics of private markets, we believe an allocation to private investments should enhance the return and reduce the risk characteristics of portfolios. We are identifying and attracting first-class managers across private equity, venture capital, private credit, and real assets to allocate capital. Our pipeline of new opportunities is robust.
In summary, we are managing portfolios with the goal of protecting capital during periods of downward volatility and participating in rising markets. This approach should allow for the compounding of capital at acceptable rates of return and guide clients towards achievement of their wealth objectives. While the potential for more turbulent markets can be unsettling, we aim to take advantage of it on your behalf by proactively executing portfolio management strategies such as tax-loss harvesting and rebalancing into high-quality assets at more attractive valuations.
Thank you for the trust you have placed in us. We look forward to connecting with you in the new year.
