Quarterly Market Commentary – Mosaic Model Portfolios

Quarterly Market Commentary – Mosaic Model Portfolios

In their quarterly update, the Multi-Asset portfolio team at Madison Investments discusses the events of the quarter, and provides an outlook for the markets moving forward.

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- Mosaic Model Portfolios

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Market Recap – Fourth Quarter 2024

The final quarter of 2024 brought to close a truly remarkable two-year run for U.S. equities. For the first time in a quarter century, the S&P 500 Index turned in back-to-back calendar year returns greater than 20%. Right up until mid-December it looked like 2024 was a lock for the S&P 500 to outgain 2023’s 26.3% showing. However, a hawkish interest rate cut by the Federal Reserve cooled the mood, and the index stumbled to finish the year with a 25% gain. And while it was generally a very good year for all stocks, with the average S&P 500 stock returning 13%, the continued extreme bifurcation between the largest growth stocks and the “average” stock was notable, making for a rough relative year for those not owning or not owning enough of the “right” stocks. The much hyped Magnificent 7 (Mag-7) stocks produced an average return of over 60% and contributed 53% of the S&P 500 Index’s total return in 2024. The Russell 1000 Growth Index, where the Mag-7 exhibits an even greater concentration, generated a 33% return, versus very respectable absolute, yet less than half as large returns from value, mid, and small cap stock indexes, where returns ranged from 12–15%.

As alluded to above, the year ended on a bit of a negative streak, with December returns nearly universally negative (except for large growth stocks, of course!), and much more modest fourth-quarter gains with the S&P 500 up 2.4% and mid and small cap indexes up less than 1%. December’s equity market decline appeared to be a reaction to the changing interest rate environment. In an odd twist of fate, the Federal Reserve delivered 1% of interest rate cuts between mid-September and year-end, yet the bellwether 10-year U.S. Treasury yield increased an identical 1%, from 3.6% to 4.6%. The jump in rates seemed to correspond to the unfortunate realization that rates may stay structurally higher for longer due to sticky inflation and a federal government addicted to debt. Higher rates made trouble for fixed income investors and spoiled what had been a decent year for bonds. The benchmark Bloomberg US Aggregate Bond Index fell -3.1% over the final quarter, taking the full year return down to +1.3% from +4.5% on September 30th.

International equity markets were especially challenged during the fourth quarter. Rising U.S. interest rates, combined with newfound tariff concerns based on the results of the U.S. presidential election, sent the dollar soaring, producing a significant headwind for unhedged non-US positions. Markets were also unnerved by political upheaval in South Korea, France, Germany, and the United Kingdom, combined with continued market disappointment in the underwhelming fiscal policy measures taken by China. All of which served to send the MSCI ACWI ex-USA Index down -7.6% for the quarter, dragging the 2024 return to a more pedestrian +5.5%.

 

Performance

As has been the case over the recent past, diversification, the cornerstone of risk management, was detrimental to performance. While that was true throughout 2024, it was especially pronounced in the fourth quarter, where positive U.S. equity performance was not enough to keep broad portfolio results above zero due to the sizeable declines in bonds and international stocks.

Portfolios benefited from our long-standing underweight to international equities, which along with the corresponding overweight to cash, provided the greatest benefit to results. Within U.S. equities, our allocation to technology stocks helped, but we were a victim of not owning enough of the Mag-7 and many of our core U.S. positions fell short of the index. An overweight to the energy sector presented an additional drag.

On the fixed income side, our below benchmark exposure to duration, or interest rate risk, was offset by a below benchmark yield, which effectively neutralized relative performance.

For the year, the portfolio themes were largely the same, just with much more positive results. Fixed income returns largely kept pace with the benchmark or outperformed in portfolios where we utilize active managers. Our preference for U.S. versus international stocks added to performance. However, elevated cash and underperformance in the U.S. equity space were the biggest detractors from performance. Within the U.S., our below market allocation to the Mag-7 stocks was behind the differential, especially in portfolios utilizing active managers. 
 

Outlook & Positioning

We enter the new year cautiously optimistic. The U.S. economic backdrop is stable, however questions remain around inflation and the true health of the labor market. A key takeaway from the election has been the abrupt change in small business sentiment. Prior to the election, small business optimism was in recessionary territory and uncertainty was at a record high. The prospect of a more favorable tax and regulatory environment was a game changer. That said, higher interest rates, tariffs, or sticky inflation could foul the mood. But, should confidence continue to grow, investment and employment are likely to follow, prolonging the economic cycle. Valuations are much less demanding outside of the largest U.S. stocks. We believe the likely drivers of continued economic growth will benefit small and mid cap stocks, particularly financials given the steep yield curve if business demand for capital expenditures heats up. In turn, we increased our exposure to both small caps and financial stocks late in the quarter.

There could very well be bouts of volatility over the first half of 2025 as markets reacclimate to a higher level of interest rates and adapt to the new administration’s economic initiatives. Provided the labor market holds and the consumer continues to spend, any downside volatility would be an opportunity for us to increase equity exposure.

We truly appreciate your confidence and partnership.