It was a mixed bag for stock market investors during the fourth quarter, with a dramatic narrowing by size and sector particularly during December. Instead of a Santa Claus Rally, it was a lump of coal for small-cap enthusiasts as the Russell 2000 dropped 8.3%. That decline reversed the strong November rally in small caps and left the index with a 1.5% gain for the quarter. The S&P 500 provided steadier performance gaining 3.1% without the November/December roller coaster ride. Mega Cap Technology stocks accounted for most of the performance, as shown by the 8.2% advance for the quarter from the Nasdaq Composite. The iShares S&P 500 Value ETF (IVE) posted a 3.4% decline for the quarter, including 14 straight days in the red, while the iShares S&P500 Growth ETF (IVW) gained 7.2%. We believe that divergent performance has resulted in significant relative bargains in small caps and value stocks, both asset classes that typically outperform when the economy is strong and with lower short-term interest rates.
Following the election in November, the impact of the incoming administration’s policies, along with possible monetary policy responses from the Federal Reserve, was at the center of focus for most investors. Whereas there was enthusiasm over President-elect Donald Trump’s pro-business anti-regulation rhetoric, there was also concern over the inflationary impact of those policies and particularly over the negative effects that could result from implementing tariffs. During the quarter, the Federal Reserve did cut rates by ¼% at both the November and December meetings, but its statements also took on an increasingly cautious tone. That cautious tone created a headwind for small caps and value stocks, as the size and pace of future interest rate cuts came into question.
Corporate earnings were solid, with profits exceeding analysts’ expectations for the seventh consecutive quarter. Although growth slowed to 5% from double digits in the previous quarter, expectations are for a return to 10% plus growth in the fourth quarter and in 2025.
The yield on the 10-year Treasury moved 77 basis points higher to 4.57%, matching its highest level in over 15 years. The U.S. dollar advanced in step with the higher interest rates to reach its highest relative value of 2024, as the interest rate differential became compelling for foreign investors.
There were some areas of concern during the quarter. Home mortgage rates finished at the highest level of the year at 7%, after approaching 6% in the previous quarter. As a result, existing home sales remained very constrained, as homeowners who locked in much lower mortgage rates were reluctant to move. With that lack of supply on the market, existing home prices continued to rise, contributing to some stickiness in the inflation data. The jobs market was another area that showed some softening as the unemployment rate crept up and wage growth slowed.
While we recognize those headwinds and the elevated level of uncertainty, we are still optimistic about the health of the U.S. economy, with moderate inflation and steady earnings growth. The Federal Reserve will remain an important actor in 2025, hopefully acting rationally and moving short-term rates to a level that consistent with a more neutral, rather than tight, monetary policy. In turn, we believe investors will act intelligently and continue to broaden their holdings outside of the artificially high momentum stocks into other equities offering greater value propositions.