At the end of most years, I look back and note a range of unexpected financial events, and 2024 is no exception. This post provides an overview and an attempt to draw some actionable conclusions.
Asset Class Performance
Amidst enormous geopolitical turmoil, the U.S. stock market continued to deliver large gains. The S&P 500 returned a total of almost 25%, and the NASDAQ returned about 25.5% in 2024. By contrast, the returns from stock markets in other countries were muted. The EAFE index, which is a composite of major developed (non-U.S.) markets, returned a total of 3.5% in 2024. EAFE includes Europe, Japan, and other countries in the Asia/Pacific region. China (which is not included in the EAFE index) returned about 29% in 2024, although this gain came on the heels of substantial negative returns in 2022 and 2023. Overall, 2024 was consistent with a longer trend of outperformance for U.S. stocks. The trailing 5-year return for the S&P 500 through 2024 is about 14.5% per year, as compared to 4.7% per year for EAFE and -4.8% per year for China. The trailing 10- and 15-year periods show a similar pattern.
The iShares S&P 500 Value ETF (IVE) returned 12% in 2024, as compared to 35.8% for the iShares S&P 500 Growth ETF (IVW). This is consistent with an extended period during which growth stocks have outperformed value stocks. The 15-year annualized return for IVE (value) is 11.4% per year, vs. 15.3% per year for IVW (growth). This represents a substantial shift relative to long-term historical periods, during which value has tended to beat growth. Back in 2020, I suggested that the benefits of value investing may be permanently diminished and the subsequent years have seen continued dominance of growth over value.
Another notable feature of 2024 was the continued under-performance of bonds. The Barclays Aggregate Bond ETF (AGG) returned a total of 1.3% in 2024, with 3-year annualized return of -2.4% per year. Over the 15-year period through 2024, AGG has returned 2.3% per year.
Challenges For Investing
The standard of practice for asset allocation is to start with a portfolio that has allocations to major stock markets based on their market capitalization (the total value of their markets). The Vanguard Total World Stock ETF (VT) is designed to represent this portfolio. VT currently has a 63.6% allocation to U.S. stocks and 35.2% allocation to non-U.S. stocks. Compared to the performance of U.S. equities over recent years, the global market cap weighted portfolio has performed relatively poorly. Even accounting for diversification benefits, allocations to international stocks have not been beneficial over the past four decades.
Similarly, conditions over the past decade or so lead to questions about conventional advice on allocations to bonds. The standard of practice is to have an increasing allocation to bonds as one ages, with a very large allocation to bonds for older people. A conventional rule has been to have your ‘age in bonds.’ So, for example, a 60-year-old would hold 60% of his or her portfolio in bonds. More recently, the standard appears to have shifted to lower bond allocations, with variants such as ‘age-10 in bonds’. The trend in bond allocation with age is seen in Target Date Funds, which are designed to capture a complete asset allocation that changes as an investor ages. These funds’ names specify an assumed retirement year, and alter the asset allocation through time to reflect this. The T. Rowe Price Retirement 2023 Fund (TRRCX) is designed for investors who plan to retire in 2030, for example. Currently, TRRCX has 28.3% of its assets in bonds (aka fixed income) and another 6% in cash. The T. Rowe Price Retirement 2050 Fund (TRRMX) has a 0.9% allocation to bonds and 2.3% in cash. There is, of course, variability in the bond allocations from different fund families for a specific retirement year. The Vanguard Target Retirement 2030 Fund (VTHRX) has a 37% allocation to bonds and a 3.1% allocation to cash, for comparison to TRRCX.
Deciding upon an allocation to non-U.S. equities and to bonds are enormously consequential for the expected risk and return of the overall portfolio. The last decade has delivered out-sized benefits for investors who have over-allocated to U.S. stocks and under-allocated to bonds and international stocks and 2024 has bolstered these benefits. That said, it is foolhardy to assume that what has worked well in the recent past will continue to do so. Overall, however, 2024 represents yet another year in a long period that appears to be anomalous, as compared with standards of practice for asset allocation.
Setting Expectations
With very high national debt and an expectation for a range of new trade tariffs, bonds continue to look fairly unattractive for 2025. The additional yield available for longer duration looks pretty paltry. Currently, Schwab’s Value Advantage Money Market Fund (SWVXX) yields 4.2% The total return for 2024 was 5.1%. Over the past 3 years, SWVXX has annualized return of 4.1% per year. The iShares Aggregate Bond ETF (AGG) has an SEC yield of 4.5% and 3-year annualized return of -1.7% per year. In fact, SWVXX has total annualized return greater than AGG over the last 1-, 3-, 5-, and 10-year periods. Do we expect that longer-term bonds will perform better than a money market fund in 2025? This all depends on interest rates. If rates come down, AGG is more likely to perform well, and vice versa. While inflation is trending downwards, the Fed is signaling that further reductions in rates are uncertain.
Stocks are expensive relative to current earnings, when compared to historical value using the price-to-earnings ratio(P/E). The current P/E for the S&P 500 is 30.6, as compared to a long-term average of around 15. The Shiller P/E, a modified P/E ratio that uses the average of the past 10 years of earnings, is currently 38.1, as compared to a long-term average of 17.2. These values suggest that share prices are high. That said, historical P/E values may no longer be a useful guide to expected returns over the next year or so (read my analysis of P/E from 2019). For some years now, I have been considering the possibility that the market’s perception of value as a basis for prices of assets is changing in fundamental ways. Is owning a share of Microsoft really fundamentally different than owning an equivalent dollar amount of Bitcoin? There are arguments to suggest that the distinctions are blurring.
Ultimately, we invest in various asset classes that we perceive to be better than simply owning dollars (or whatever currency we are holding). Owning cash means that we are betting that inflation is not a concern. This is clearly not the case in current conditions. Owning government bonds means that we have faith the the issuing country will manage its currency in a way that is favorable to lenders (low inflation, economic stability, and controlling debt levels). These factors are a cause for concern. Cash and cash equivalents (such as money market funds) help to manage liquidity risk, the possibility that you need to get your hands on money quickly, so money market funds are a foundation of near-term risk management, even if their long-term expected returns are weak.
How do we compare the tradeoff of owning dollars vs. shares in the aggregate value of U.S. companies (stocks)? U.S. shares are expensive, as noted above, but the U.S. private sector economy appears to be doing well. Trade tariffs would be a mixed bag, with some benefits and some costs for U.S. firms, but would be expected to be more costly for non-U.S. firms. Tariffs tend to contribute to higher inflation, so interest rates are likely to remain elevated for an extended period if tariffs increase substantially. Small- and medium-sized companies will continue to have a harder time until interests decline. Meanwhile, there are major upheavals in economies around the globe, and an increased orientation towards trade tariffs are likely to contribute to uncertainty. Non-U.S. equities have been under-performing and conditions continue to be volatile, especially given that the U.S. posture relative to cooperative multi-country organizations is in decline (NATO, WHO, etc.). Shares of tech stocks are especially expensive, and it seems undeniable that some of the valuations are far too high. Overall, however, we are going through a period of burgeoning innovation.
In summary, money market funds (aka ultrashort bond funds) and larger-cap U.S. equities continue to look like the most attractive asset classes relative to international equities, smaller companies, and bonds. That said, balanced asset allocations that contain a wide mix of assets classes are a sensible bet for people with a hands-off orientation to their investments. In this regard, target date funds continue to be a reasonable choice for the average investor.
Final note: As always, nothing in my posts is advice. Investors need to make their own decisions or work with advisors who can provide advice.
Geoff Considine on Finance and Economics 