Otso Monthly - December 2024
Performance Summary
December was an ‘interesting’ month for US financial markets. Both the US markets and the AUD/USD exchange rate significantly influenced performance.
The month started with enthusiasm following Donald Trump’s election victory. However, enthusiasm waned following the FOMC’s Summary of Economic Projections (SEP), and Jerome Powell’s December statement. The statement predicted 50 bps of interest rate cuts in 2025 (vs 100bps of cuts in the prior SEP). The S&P 500 fell around 2.7% in December.
The US stock performance is only part of the issue: the Australian Dollar tells the other part of the story. The US Opportunity Fund is based in Australian Dollars. The AUD fell 4.6% relative to the USD. This means that in AUD terms, US assets increased in value. Conversely, the USD appreciated 4.8% relative to the AUD.
How then did this influence markets and performance? The benchmark return was 1.96%. This is the return on the SPY in AUD terms. The US Opportunity Fund returned 2.27% to investors net of fees. Again, this is in AUD and we must recall that both the US stock market and the Fund benefited from improvements in the USD.
Returns for the Fund vs the Benchmark. Numbers are preliminary. The SPY (AUD) and Otso US Fund returns are in AUD.
What drove markets in December?
December had two halves, bisected by the FOMC meeting and the Summary of Economic Projections. This is clear from the SPY (i.e., S&P500 ETF) price series. Before the FOMC meeting, SPY had a lukewarm month. After the meeting, the SPY’s trajectory turned negative.
Why was the FOMC meeting so negative for markets? The FOMC’s inflation projections for 2025 increased, slightly to 2.5% (as at December) from 2.1% (as at September). The higher inflation projections are inherently bad for many stocks, including small caps. They increase the costs of doing business, especially when there are limits to whether companies can pass on cost increases to customers.
The higher-inflation projections also manifested in higher interest rate projections. In the September projections, the 2025 policy rate was projected to be 3.4% (a 100 bps fall). By contrast, in the September projections, the 2025 policy rate was projected to be 3.9% (a 50bps fall).
The question is how to invest following the significant market declines in December. The median target price for the S&P500 is 6746, according to Factset. Thus, it is important to remain invested. However, it is equally important to be strategic about asset selection. This includes considering which firms are least likely to lose from higher interest rates.
Themes looking into 2025
There are several themes looking into 2025. As indicated, interest rates might be higher than previously anticipated. Areas that we will look for are:
Trade tensions: it is important to continually consider whether, and to what extent, the Trump administration imposes tariffs. The rhetoric surrounding tariffs changes frequently. However, the proposal presently appears to involve a universal tariff on ‘critical’ items. However, this could change. Further, the Trump administration has signaled a desire to use tariffs for geopolitical reasons, including in relation to Canada, Mexico, Panama, and potentially Denmark. Thus, supply changes are relevant when analyzing companies.
AI Regulation: The EU and UK have signaled an intention to regulate AI. This could include copyright controls, and the use of AI in ‘sensitive’ areas, such as insurance and banking. However, AI will continue to be a dominant theme.
US Deregulation and takeovers: The Trump administration has signaled a push for deregulation. This could benefit fossil fuel companies. However, it could also enable acquisitions in 2025 whereas acquisitions were more difficult and time consuming to complete under the Biden/Harris administration.
Cryptocurrencies: The US Opportunity Fund focuses on stocks, rather than crypto. However, the incoming SEC Chair is positively pre-disposed to cryptocurrencies. Similarly, Donald Trump as flagged the possibility of a strategic Bitcoin reserve. Thus, the incoming administration is more positive – or less negative – than the prior one. However, significant changes inchoate at present.
Interest rates and inflation: As indicated above, interest rates are projected to fall by less in 2025 than previously anticipated. This can create some headwinds for high duration stocks, and emphasizes the need to scrutinize corporate fundamentals, including balance sheets and earnings.
These factors – in addition to a slow normalization of interest rates – will influence financial markets in 2025.