
It was a challenging quarter across the multi-asset universe (Figure 1) as the U.S. dollar strengthened, the 10-year U.S. Treasury jumped 90 basis points (bps) and U.S. inflation data surprised to the upside. The Federal Reserve (Fed) delivered a “hawkish” rate cut in December and shifted its forward guidance from three to just two potential 25-bprate cuts in 2025.
Figure 1: Index Performance, %
Markets were led lower by international equities as financial conditions tightened
4Q24 |
Oct |
Nov |
Dec |
|
U.S. Equity |
||||
Russell 3000® |
2.6 |
-0.7 |
6.7 |
-3.1 |
S&P 500® |
2.4 |
-2.4 |
5.9 |
-2.4 |
WisdomTree US Quality Div Growth |
-2.2 |
-1.3 |
4.1 |
-4.8 |
S&P 500 Value® |
-2.7 |
-1.3 |
5.8 |
-6.8 |
S&P 500 Growth® |
6.2 |
-0.6 |
5.9 |
0.9 |
S&P MidCap 400® |
0.3 |
-0.7 |
8.8 |
-7.1 |
S&P MidCap 400 Value® |
1.5 |
0 |
8.9 |
-6.7 |
S&P MidCap 400 Growth® |
-0.8 |
-1.3 |
8.8 |
-7.6 |
Russell 2000® |
0.3 |
-1.4 |
11 |
-8.3 |
Russell 2000 Value® |
-1.1 |
-1.6 |
9.6 |
-8.3 |
Russell 2000 Growth® |
1.7 |
-1.3 |
12.3 |
-8.2 |
MSCI USA IMI/Real Estate |
-7.9 |
-3.4 |
4.1 |
-8.4 |
International Equity |
||||
MSCI ACWI Ex USA IMI |
-7.6 |
-5 |
-0.8 |
-2 |
MSCI World Ex USA |
-7.4 |
-2.7 |
0.2 |
-2.7 |
MSCI World ex USA Quality |
-10.6 |
-3 |
-1.2 |
-3 |
MSCI World Ex USA Value |
-6.5 |
-4.5 |
0 |
-2.1 |
MSCI World Ex USA Growth |
-8.3 |
-5.7 |
0.5 |
-3.2 |
MSCI World Ex USA Small Cap |
-7.9 |
-5.7 |
0.4 |
-2.6 |
MSCI EM IMI |
-7.9 |
-4.4 |
-3.4 |
-0.3 |
Fixed Income |
||||
Bloomberg U.S. Aggregate |
-3.1 |
-2.5 |
1.1 |
-1.6 |
Bloomberg Municipal |
-1.2 |
-1.5 |
1.7 |
-1.5 |
Bloomberg U.S. Corporate High Yield |
0.2 |
-0.5 |
1.2 |
-0.4 |
Bloomberg EM USD Aggregate |
-1.5 |
-1.4 |
1.1 |
-1.2 |
Source: Morningstar Inc.; Data as of 12/31/2024
The risk of a U.S. government shutdown in mid-December was also a material headwind as financial conditions tightened and every major asset class, except U.S. large-capitalization (cap) equities, reversed their gains since November 5 by the end of the year. The Bloomberg U.S. Aggregate Bond Index had its worst return since third quarter 2023 and lagged below- investment-grade bonds despite relatively low credit spreads. Even with the S&P 500’s positive quarterly return, performance concentration increased, and market breadth fell to a 12-month low by year end (Figure 2).
Figure 2: Percent of S&P 500 Companies Above Their 200-Day Moving Average
Despite the positive return, breadth fell substantially in Q4
Source: Bloomberg L.P.; Data as of 12/31/2024
View accessible version
Key Theme Recap
“Hawkish” rate cut: Despite its December rate cut, the Fed’s outlook for fewer cuts in 2025 was a hawkish pivot, in our view. With most major central banks expected to continue cutting rates well into 2025, the U.S. dollar could strengthen if the Fed cuts rates less than expected.. The strengthening dollar could lead to further strain on international equities, which are already expecting weaker 2025 economic and earnings growth rates relative to the U.S.
The U.S. deficit and interest rates: During the same week of December as the Fed update, the federal government headed toward a potential shutdown over funding concerns. From an investment perspective, the event was so notable that long-term interest rates, which are less influenced by Fed policy than short-term interest rates, moved higher; typically, long-term rates tend to move lower during periods of fiscal policy uncertainty. In our view, this serves as a reminder of the unique environment investors face — one characterized by a historically wide federal deficit despite robust economic growth. As such, we believe long-term interest rates face more pressure to the upside, which remains a headwind for lower-quality companies, developed international equities and longer-duration fixed income.
The deficit and emerging market interest rates: Emerging market (EM) equities reversed their third-quarter gains on several country-specific and macro-driven headwinds. Various EM countries struggled in the fourth quarter due to monetary and fiscal policy issues, but not solely due to U.S. policy actions. For example, Brazil’s currency fell to the weakest level against the U.S. dollar due to the announcement of fiscal stimulus measures. On the monetary policy front, the Reserve Bank of India surprised consensus by not cutting its policy rate in December, which helped drive the rupee to the lowest level against the U.S. dollar on record. In short, not all recent dollar strength is a direct result of U.S. monetary or fiscal policy, yet U.S. policy issues remain a headwind for international equities (Figure 3).
Figure 3. U.S. Dollar Index and U.S. Trade-weighted EM Currency Index
Dollar strength could remain a headwind for global equities
Source: Bloomberg L.P.; Data as of 12/31/2024
View accessible version
Which Asset Classes Led in Q4
“Catch-up” rally: Investor anticipation for Fed rate cuts began with the July 11 Consumer Price Index (CPI) report. Not only was the year-over-year growth rate lower than consensus expectations, but month-over-month growth was negative, a first since 2020. Markets initially reacted to the CPI report by rotating out of mega-capitalization growth stocks and into smaller-cap stocks. This was a clear break from the market dominance of a few, large tech companies over the preceding year. However, we believed then, and continue to believe now, that to see a sustained shift away from U.S. large-cap stocks, the earnings outlook for other asset classes needs to improve. One of the biggest challenges to broadening earnings growth is weak global manufacturing activity. Considering the two largest sectors within small- and mid-cap equities are Industrials and Financials, without an upturn in the global business cycle, we expect any performance rotation away from large-cap stocks will be short-lived.
Most central banks are now easing monetary policy: While the size of the Fed’s rate cut at 50 bps (versus the more widely expected 25 bps) came as somewhat of a surprise, the bigger surprise was the People’s Bank of China’s (PBOC’s) announcement of several policy rate cuts and pledges to stabilize China’s financial markets. With these actions by the Fed and PBOC, the Bank of Japan (BOJ) remains the only major central bank that has yet to begin easing policy. We expect loosening policy to become a tailwind for both financial markets and economic growth, albeit with a lagged effect.
Volatility likely to continue through to the U.S. election: Despite global monetary policy easing, market volatility returned in the third quarter. For example, on August 5, the CBOE Volatility Index (VIX) reached the highest level since March 2020 in reaction to a surprise interest rate hike by the BOJ (Figure 4). While the VIX recovered within two weeks, the brief, but sharp, market pullback reminded investors that global central bank action can still have a significant influence on investor sentiment in the short run, whether it be positive or negative. For example, the VIX futures contract that expires close to the U.S. presidential election on November 5 is priced more than 10% above the 10-year average, suggesting investors should continue to prepare for volatility amid election season.
U.S. Large-cap Equity
Our thesis: We believe U.S. large-cap is the long-term growth and innovation engine of public equities given its overall sustainable, high-quality fundamental characteristics.
What worked in the quarter: The Information Technology and Consumer Discretionary sectors drove market returns, with four mega-cap stocks contributing more than the rest of the index. Despite rising interest rates, which are typically viewed as a negative for high-valuation growth stocks, artificial intelligence (AI) demand and improved investor sentiment post-election were material tailwinds for those stocks.
Looking ahead: Over the past few years, index returns and earnings growth have been driven almost exclusively by mega-cap companies. Consensus expects earnings growth to broaden across large-cap in 2025 and consequently, sectors such as Financials, Health Care and Industrials should face easier comparable-company analysis.
U.S. Mid-cap Equity
Our thesis: We believe in the long-term benefit of the mid-cap premium and its associated growth prospects. Additionally, mid-cap should benefit from its U.S.-centric revenue exposure over the long term.
What worked in the quarter: Similar to large-cap, mid-cap returns were concentrated among a few sectors; in this case, Financials and Energy. While investor sentiment dramatically improved post-election, both sectors had sluggish third-quarter earnings growth results. Therefore, earnings multiples rose to the highest level in more than two years.
Looking ahead: In our view, the outlook for mid-cap depends on interest rates. While mid-cap valuations are relatively low, higher long-term interest rates are a material headwind for earnings growth and margin expansion.
U.S. Small-cap Equity
Our thesis: We believe in the long-term benefit of the small-cap premium and its associated growth prospects. Additionally, small cap should benefit from its U.S.-centric revenue exposure over the long term.
What worked in the quarter: Unlike large- and mid-cap equities, whose performance was dominated by the largest companies, the Russell 2000 lagged its equal-weight counterpart by nearly 300 bps, implying that market breadth widened in the quarter. That said, sector concentration remained as Information Technology accounted for more than the entire gain of the index, led by semiconductor and software industry stocks.
Looking ahead: With a forward price-to-earnings ratio multiple of 24.2 times (x), well above its long-term average of 21.5x, multiple expansion may be difficult for small-cap equities. However, if the U.S. economy remains resilient and the Fed continues to lower interest rates, earnings growth, which is expected to be 44.7% in 2025, has the potential to compress earnings multiples.
Which Asset Classes Lagged in Q4?
EM Equity
Our thesis: EM accounts for approximately 40% of global GDP, 35% of global consumption and 75% of global economic growth, yet only 8% of global equities. We continue to believe demographic trends, long-term economic growth potential and the multi-year earnings outlook in EM remain supportive of the asset class.
What happened in the quarter: EM equities reversed their previous quarter’s gains as softening growth impacted consumer spending and manufacturing activity. Additionally, a strengthening U.S. dollar and growing uncertainty about future U.S. foreign trade policy were challenges. Impacted by geopolitical risk, South Korea was the largest detractor, while Taiwan was the top contributor as demand for AI continues to accelerate.
Looking ahead: Given trade policy uncertainty and lackluster domestic demand in China, we anticipate increased volatility for EM equities in 2025. That said, we favor EM relative to developed international due to stronger fundamentals. Additionally, potential headwinds from trade policy changes may ultimately be offset by accelerating earnings growth as most EM central banks are loosening policy.
Developed International Small-cap Equity
Our thesis: We believe in the long-term benefit of a small-cap premium for developed international markets. Unlike developed international large cap, small-cap companies are typically found outside core Europe, such as Japan, Canada and the U.K., and offer stronger growth prospects, acting as an innovation engine.
What happened in the quarter: International small-cap equities were pressured by a strong U.S. dollar and declined within the Eurozone and U.K. as economic growth stalled, despite major central banks easing interest rates.
Looking ahead: From a valuation and earnings growth perspective, we believe developed international small-cap remains attractive relative to developed international large-cap equity, as it has higher weightings in sectors with stronger growth potential.
Developed International Equity
Our thesis: Developed international large-cap equities provide diversification for multi-asset portfolios and have the potential to outperform U.S. equities at times.
What happened in the quarter: International equities sold off during the quarter as rising U.S. long-term interest rates strengthened the U.S. dollar, pressuring performance. Additionally, fragmentation within Eurozone and U.K. governments created challenges for fiscal policy, which further undermines the outlook of the region. U.S. trade policy uncertainty and the region’s slowing economic growth added to headwinds.
Looking ahead: We continue to have a negative view of developed international equity heading into 2025. Despite relatively low valuations, the earnings outlook for the Eurozone remains clouded by a weak economic backdrop. The Manufacturing sector has remained in contraction territory for more than two years, which casts doubt on an economic recovery, especially for an economy that is still reeling from the energy crisis that started in 2022.
Accessible Version of Charts
Figure 1: Index Performance, %
Markets were led lower by international equities as financial conditions tightened
4Q24 |
Oct |
Nov |
Dec |
|
U.S. Equity |
||||
Russell 3000® |
2.6 |
-0.7 |
6.7 |
-3.1 |
S&P 500® |
2.4 |
-2.4 |
5.9 |
-2.4 |
WisdomTree US Quality Div Growth |
-2.2 |
-1.3 |
4.1 |
-4.8 |
S&P 500 Value® |
-2.7 |
-1.3 |
5.8 |
-6.8 |
S&P 500 Growth® |
6.2 |
-0.6 |
5.9 |
0.9 |
S&P MidCap 400® |
0.3 |
-0.7 |
8.8 |
-7.1 |
S&P MidCap 400 Value® |
1.5 |
0 |
8.9 |
-6.7 |
S&P MidCap 400 Growth® |
-0.8 |
-1.3 |
8.8 |
-7.6 |
Russell 2000® |
0.3 |
-1.4 |
11 |
-8.3 |
Russell 2000 Value® |
-1.1 |
-1.6 |
9.6 |
-8.3 |
Russell 2000 Growth® |
1.7 |
-1.3 |
12.3 |
-8.2 |
MSCI USA IMI/Real Estate |
-7.9 |
-3.4 |
4.1 |
-8.4 |
International Equity |
||||
MSCI ACWI Ex USA IMI |
-7.6 |
-5 |
-0.8 |
-2 |
MSCI World Ex USA |
-7.4 |
-2.7 |
0.2 |
-2.7 |
MSCI World ex USA Quality |
-10.6 |
-3 |
-1.2 |
-3 |
MSCI World Ex USA Value |
-6.5 |
-4.5 |
0 |
-2.1 |
MSCI World Ex USA Growth |
-8.3 |
-5.7 |
0.5 |
-3.2 |
MSCI World Ex USA Small Cap |
-7.9 |
-5.7 |
0.4 |
-2.6 |
MSCI EM IMI |
-7.9 |
-4.4 |
-3.4 |
-0.3 |
Fixed Income |
||||
Bloomberg U.S. Aggregate |
-3.1 |
-2.5 |
1.1 |
-1.6 |
Bloomberg Municipal |
-1.2 |
-1.5 |
1.7 |
-1.5 |
Bloomberg U.S. Corporate High Yield |
0.2 |
-0.5 |
1.2 |
-0.4 |
Bloomberg EM USD Aggregate |
-1.5 |
-1.4 |
1.1 |
-1.2 |
Source: Morningstar Inc.; Data as of 12/31/2024
Figure 2: Percent of S&P 500 Companies Above Their 200-Day Moving Average
Despite the positive return, breadth fell substantially in Q4
Date |
Percent of S&P 500 Companies Above Their 200 Day Moving Average |
12/31/2024 |
56.51 |
11/29/2024 |
76.51 |
10/31/2024 |
69.74 |
9/30/2024 |
81.2 |
8/30/2024 |
79.6 |
7/31/2024 |
80.2 |
6/28/2024 |
70.28 |
5/31/2024 |
72.49 |
4/30/2024 |
72.49 |
3/28/2024 |
85.97 |
2/29/2024 |
76.55 |
1/31/2024 |
71.69 |
Source: Bloomberg L.P.; Data as of 12/31/2024
Figure 3. U.S. Dollar Index and U.S. Trade-weighted EM Currency Index
Dollar strength could remain a headwind for global equities
Date |
U.S. Trade-Weighted EM Currency Index |
U.S. Dollar Index |
12/31/2024 |
110.8489 |
108.487 |
6/30/2024 |
106.7156 |
105.866 |
12/31/2023 |
103.0791 |
101.333 |
6/30/2023 |
102.9582 |
102.912 |
12/31/2022 |
105.5436 |
103.522 |
6/30/2022 |
104.1868 |
104.685 |
12/31/2021 |
101.6049 |
95.67 |
6/30/2021 |
97.9525 |
92.436 |
12/31/2020 |
96.9787 |
89.937 |
6/30/2020 |
103.2382 |
97.391 |
Source: Bloomberg L.P.; Data as of 12/31/2024