Though December did not deliver higher stock prices market observers were still inclined to celebrate with the S&P 500 up 25% for the year. The Wall Street Journal headlined “Dow Ends Lower on Last Day of Stellar Year for Stocks” adding, in the accompanying story, “US stocks wrapped up a stellar 2024, with the S&P 500 notching its best consecutive years since 1997 and 1998.” December joined April and October as the only negative return months for the year and the month also included the venerable Dow Jones Industrial Average’s ten-day losing streak, its longest in fifty years. As has been true of this market in recent years, 2024’s market was less than an equal opportunity one as the equal weight S&P 500 returned 13%, the Small-Cap S&P 600 8.7% and Foreign Developed Markets 3.7%.
While most investor’s attention has been focused upon the equity markets and those in the United States in particular a case can be made that it is the bond market that is the more interesting market because it contributes a great deal to explaining both the behavior of the equity markets in the recent past and quite possibly in the year ahead. It is generally agreed that the 10 Year US Treasury rate is the single most important interest rate in this country and globally. For instance, it is this rate that determines the mortgage rate home purchasers pay. Looking at a chart of that rate from 2020 to the present is like standing at the bottom of a staircase and gazing upwards. In 2020 that rate was below 1%. In 2021 it rose to 2% and in 2022 to 3 1/2%. In 2023 it touched 5% and since then has floated back and forth between 4% and 5%. Many investors would not view the reason for rising interest rates as particularly difficult to explain; inflation and the Federal Reserve’s interest rate increases implemented in its effort to push inflation back to a 2% level. There is, however, a piece missing in this explanation. In June 2022 the rate of inflation was 9%. Currently, by most measures, it is now at or below 3%. So, if inflation has declined by more than 6%, why are interest rates at or close to their highest levels?
Most economic commentators are focused on this countries rate of economic growth and believe a correlation exists between that rate, the future level of inflation and the likelihood of future interest rate reductions by the federal reserve but with all due respect I would suggest this is not true. Evidence that this is so is provided by what has occurred in the past three years. The Federal Reserve raised interest rates by 5 ¼%, the rate of economic growth accelerated in 2023 and 2024, and the rate of inflation has fallen sharply. There is no cause and effect there and why it is being used to explain the current elevated level of interest rates is thus nonsensical. So…what is the actual explanation for the current behavior of interest rates?
What we are discussing is the cost of money, the interest rate required to establish a balance between the amount of money that our government needs to borrow and those who have the money to lend. The provision of the required supply of money is referred to as liquidity and the Federal Reserve and the US Treasury have no higher priority that to be certain that the “pool” of the required liquidity is sufficient to satisfy the funding requirements of our government. In 2024 the soon to be former Secretary of the Treasury Janet Yellen shifted the maturity of its debt issuance from longer maturities to treasury bills with maturities of one year or less. The result is that 30% of the $28 trillion of outstanding US debt must be refinanced this year. All that treasury bill issuance the prior two years was liquidity enhancing and positive for both US stock prices and our rate of economic growth while depressing the level of longer-term interest rates. The government’s dependence on short term financing though is potentially harmful to financial stability and incoming Treasury Secretary Scott Bessent has vowed to shift more debt issuance to longer maturities.
This explains what investors are currently experiencing. What is positive for the prudent management of our public finances is not necessarily positive for the stock market, the rate of economic growth or the level of longer-term interest rates. The incoming administration is aware of this and will likely ask us to endure the short-term unpleasant consequences blaming those on the prior administration while hoping that circumstances will begin to improve sufficiently to enhance its political prospects in time for the 2026 mid-term elections. This is not to suggest that our experience as investors is likely to be solely influenced by politics, but it is to suggest that Jay Powell, the Federal Reserve and the rate of inflation were never as influential in influencing the economy and financial markets as they were given credit for.
50/50 portfolios returned -2.6% for the month weighted down by equities -3.2% return partially offset by fixed incomes +1.2%. The quarter included two of the three negative months for the year with equities -0.73%. The quarter’s rise in interest rates resulted in fixed income returning -4.2%. For the year portfolios returned 10.06% with equities contributing 17.5% and fixed income 2.6%. Ten Year US Treasury rates began the year at 3.88%, hit their peak level of 4.70% on April 11th, experienced their low of 3.63% on September 16th and closed the year at 4.58%.
Mark H. Tekamp/January 12, 2025