What We Think

For many Americans, the spectacle of the Times Square ball drop on New Year’s Eve brings feelings of excitement for what we’ve accomplished and anticipation of opportunities that await. In a similar way, many investors are closing the books on another big year for markets and preparing for what’s ahead. As the media spotlight hones in on a glittery ball in New York, investors may be turning their attention to another moving target: company performance.

Our sense is much of the excitement that drove stocks up 25% in 2024 was a product of anticipated profit growth coming in 2025. This quarterly letter will focus on the micro- and macro-building blocks that are helping companies grow, as earnings are increasingly in the spotlight.

Steady economic growth supports earnings

Before we get to profits, let’s recap some of the broader economic trends that are generating demand for consumption and sales. As the Federal Reserve attempts to maintain a stable economy, it focuses on two primary economic indicators, labor markets and inflation, both of which settled in a moderate range in 2024. The Fed’s interest rate hikes have brought inflation down to a level that has allowed Powell to cut rates in hopes of avoiding job losses and recession.

With 3% growth last year, the U.S. economy grew faster than other large developed markets such as Europe with 1% growth and Japan with zero growth. China is growing in the mid-single digits, but we have concerns over excess housing and a shrinking population that may pressure the economy in the long term. In this broader context, we continue to favor exposure to the United States.

While the macro economy seems supportive of U.S.-based companies, there are rumblings under the surface. For example, stocks fell sharply on December 18 after the Fed signaled that slightly hotter inflation may limit the number of interest rate cuts in 2025. These types of downside surprises may suggest that the broader economy may continue to encounter a few bumps along a path of durable growth.

Bonds remain attractive

With inflation at 3% (above the Fed’s goal of 2%), interest rates are hovering above recent historical levels, offering investors mid-single-digit returns for high-quality Treasuries and corporate bonds. Typically, we see bond yields move in the same direction as inflation and economic growth, suggesting that a steady economy and slightly hotter inflation may sustain higher bond yields as we kick off the new year.

Looking back at 2024, most bond yields rose during the year, which led to fairly low total bond returns. The Bloomberg Aggregate, a basket of high-quality government and corporate bonds, posted ~1% return for the year.

When interest rates rise, bond prices typically decline. Despite the modest returns last year, we continue to favor high quality bonds—especially corporates, which slightly outperformed Treasuries in 2024. We see these types of bonds as a good way to add diversification to a more volatile stock portfolio, while also benefiting from a steady income stream has often exceeded inflation. In the coming year, we are optimistic that steady economic growth will continue to support attractive bond yields.
Rising expectations for stocks

For the past two years, artificial intelligence and the broader technology sector have been the major market drivers. However, in 2024 we saw stocks rise faster than corporate profits, which expanded by about 10%. This disconnect suggests that investors purchased stocks in anticipation of future growth. That brings us to our theme for this client letter, as the investor spotlight shines on future earnings. With expectations of ~15% profit growth in the coming year, we will be watching for upside or downside earnings “surprises” (either above or below expectations), which we believe will ultimately drive market performance in 2025.

How are we positioning?

As broader markets wrap up the best two-year stretch since the late 1990s, we are taking a somewhat cautious approach to 2025, while also keeping an eye on favorable long-term opportunities. We continue to hold a diversified portfolio of growth companies, including those with exposure to AI, along with defensive dividend payers in case earnings slow and sentiment reverts toward more stable business models in consumer discretionary, healthcare, and utilities. We also continue to favor a “fully invested” portfolio approach above a “market timing” approach. Even if earnings disappoint and stocks take a short-term breather, we would rather be in the market for a long-term recovery and expansion.

As we enter a new year, we anticipate steady economic growth, though we are keeping a close watch on investor sentiment as the spotlight shifts toward companies executing on earnings results. In 2025 and beyond, we have high conviction in fully invested portfolios across a diverse set of stocks and bonds with the potential to meet or exceed investor expectations, ever mindful your long-term goals and objectives.
We wish you a prosperous new year!

Michael Bailey, CFA
Director of Research

Michael Mussio, CFA, CFP®
President