4th Quarter Market Commentary “From Rally to Reality”
The year 2024 delivered another extraordinary chapter for equity markets. The S&P 500 rallied, fueled by optimism around Federal Reserve rate cuts and cooling inflation, and clarity from the highly anticipated presidential election results. This marked the second consecutive year of gains exceeding 20%. However, prolonged rallies often come with heightened risks, as history reminds us.
The drivers of 2024’s success tell a story of concentrated leadership and elevated valuations, with key metrics surpassing levels last seen during the tech bubble. Fixed-income markets, while stabilizing, offered muted returns as investors grappled with shifting rate expectations and rising correlations.
As we turn to 2025, the risk landscape grows more complex, with historical patterns suggesting heightened volatility ahead. Our RiskFirst® approach remains central to balancing opportunity and caution as we prepare portfolios for what could be a pivotal year.
When Markets Defy Predictions
The S&P 500 surged 25% in 2024, driven by continued optimism around easing inflation and a resilient U.S. economy-signaling what many see as a successful soft landing orchestrated by the Federal Reserve. This remarkable performance far exceeded Wall Street’s projections at the start of the year, as analysts once again failed to anticipate the market’s trajectory. In fact, 2024 marked the fifth consecutive year where economists were unable to predict even the range of the index’s year-end close, highlighting the persistent challenges of forecasting equity markets-even for the most seasoned experts.
Undeterred by their track record, economists have already released their predictions for 2025. Yearend return estimates range from Oppenheimer’s bullish +21% to Cantor Fitzgerald’s more conservative +2%, reflecting optimism amongst these analysts. However, given the consistent inaccuracy of these forecasts, history suggests the market’s path may yet again surprise us.
Another Year, Another Miss
Sources: Bloomberg, Redwood. As of 1/21/2025. Date Range from 1/1/2020 – 12/31/2024. For illustration purposes only.
Narrow Leadership
Over the past two years, the S&P 500’s performance has been dominated by a concentrated set of companies, putting the index’s fate in the hands of just a handful of stocks. Since the October 2022 market bottom, the top 10 stocks alone have accounted for 50% of the index’s total return, with the remaining 490 companies contributing the other half. In 2024, the top ten stocks were responsible for over 60% of the S&P 500’s return.
This extreme concentration not only skews performance but amplifies risks for investors reliant on the broader market. For example, Nvidia, the semiconductor powerhouse, has become a major driver of the S&P 500’s growth, representing a disproportionate share of returns and a significant portion of the U.S. economy itself. In fact, the current value of Nvidia alone is over 10% of the entire U.S. GDP (as of 1/24/25).
While concentrated leadership has driven short-term gains, it also increases potential vulnerabilities if these leaders falter. Investors must weigh the opportunities of riding this momentum against the risks of over-reliance on a narrow group of companies.
The Weight of a Few
Sources: Bloomberg, Redwood. Data as of 1/24/2025. Date Range 10/12/2022– 12/31/2024 & 12/31/2023 – 12/31/2024. For illustration purposes only.
A Challenging Starting Point
As President Trump begins his term in 2025, he inherits a market with the highest equity valuations ever seen at the start of a presidential administration. The S&P 500’s CAPE ratio-a measure of valuation comparing stock prices to their long-term earnings-now stands at an unprecedented 37.8. Elevated valuations like these reflect strong investor optimism but also leave markets more vulnerable to shifts in policy or economic conditions.
No administration has ever faced such lofty market metrics upon taking office. This creates unique challenges, as decisions made by the incoming administration could have an outsized impact on financial markets, amplifying both risks and opportunities. Historically, periods of elevated valuations have often been followed by heightened market volatility, underscoring the importance of managing downside risks.
Presidents Inheriting High Valuations
Sources: Bloomberg, Redwood. Data as of 1/24/2025. For illustration purposes only
Valuations Set the Stage
The expensive nature of today’s equity markets warrants a closer look at how valuations impact long-term returns. In this scatterplot, each dot represents a point in time, comparing the S&P 500’s forward price-to-earnings (P/E) ratio with its subsequent 10-year annualized return. The pattern is clear: when valuations are low, future returns tend to be higher. Conversely, when P/E ratios are high, future returns are typically much lower.
At today’s forward P/E ratio of 25, the S&P 500 sits firmly on the higher end of the valuation spectrum. Historically, similar levels have preceded a decade of lackluster performance, in stark contrast to the robust returns investors have enjoyed recently.
Returns Post P/E
Sources: Bloomberg, Redwood. As of 1/7/2025. Date Range from 5/31/1990 – 12/31/2024. For illustration purposes only
Fixed-Income Frustration
Despite starting the year with attractive yields (4.53% for U.S. Aggregate Bonds and 5.06% for Investment-Grade Corporate Bonds) public fixed-income delivered lackluster total returns for the year. On top of interest and dividends earned, total return also incorporates changes in price. In 2024, bond prices fell as market expectations shifted toward “higher rates for longer,” even with the Fed cutting rates by 100 basis points which under normal circumstances would have boosted current bond values.
The result was that higher yields could not fully offset the drag from declining bond prices, leaving total returns nearly flat. This underwhelming performance has offered little relief for U.S. Aggregate Bonds, which suffered drawdowns of -18.4% in 2022 and, as of the end of 2024, remain in a prolonged decline spanning over four years. For many, these asset classes represent core fixed-income allocations, which is why it is so important to understand the interplay between yield, price, and total performance.
Yields Can’t Save It
Sources: Bloomberg, Redwood. Data as of 1/7/2025. Date Range 1/2/2024 – 12/31/2024. For illustration purposes only
Yield Curve Clues
The optimism surrounding Fed rate cuts in 2024 has been tempered by signals from the 2-year Treasury yield. Over the past 25 years, the 2-year Treasury yield has emerged as a surprisingly strong indicator of Federal Reserve policy. While the Fed is often seen as steering the short end of the yield curve, it’s the 2-year yield, which is driven by the market’s expectation of shortterm interest rates over the next two years, that frequently moves first.
This could be a signal for shifts in monetary policy before they happen. This dynamic is playing out again today, with the 2-year yield rising above the Fed Funds Rate-a potential signal that markets expect higher rates or a prolonged period of elevated borrowing costs. As we head into 2025, this divergence between market pricing and central bank policy point to uncertainty surrounding the interest rate landscape.
Ahead of the Fed
Source: Bloomberg, Redwood. Data as of 1/24/2025. For illustration purposes only.
Risk After the Rally
After two consecutive years of 20%+ market gains, the road ahead for 2025 may feel uncertain. While recent performance has been exceptional, history suggests that such strong back-to-back gains often give way to increased volatility. As this chart illustrates, years following two consecutive 20%+ market rallies have historically experienced an average maximum drawdown of -23.8%, with some drawdowns exceeding 40%.
While our portfolios remain largely risk-on at present, it’s essential to prepare for the potential challenges 2025 may bring. Managing risk and staying vigilant will be critical in navigating what could be a more turbulent year.
2025 Landscape
Sources: Bloomberg, Redwood. As of 12/31/2024. Date Range 1930 – 2024. For illustration purposes only.
History’s Hardest Lessons
The remarkable optimism of 2024 serves as a reminder of how quickly markets can climb-but history also warns of how quickly gains can evaporate. The story of the Nasdaq Composite following the dot-com bubble is a stark example. Following its meteoric rise, the index crashed in the early 2000s, ushering in a “lost decade” that took 15 years to fully recover from. Even worse, between 2000 and 2012, the Nasdaq Composite index delivered annualized returns of -1.5%. This illustrates the long-lasting impact that significant losses can have on portfolios, with years-or more than a decade in this case-needed to claw back gains.
Ignoring these lessons leaves portfolios vulnerable to prolonged setbacks. That’s why a disciplined approach remains essential for navigating potential volatility in 2025, helping to mitigate large drawdowns and protect your financial future.
Decade in the Red
Sources: Bloomberg, Redwood. Data as of 1/10/2025. Date range from 1/2/1990 – 1/8/2025. For illustration purposes only.
When Bonds Don’t Protect
For those that believe traditional methodologies may be sufficient to navigate the risks ahead, the recent shift in the relationship between stocks and bonds presents a clear challenge. Historically, the correlation between stocks and bonds has been negative, meaning they typically moved in opposite directions. When stocks fell, bonds typically rose-allowing bonds to act as a stabilizer during market downturns. This negative relationship provided reliable diversification and helped reduce overall portfolio risk.
In recent years, this relationship has reversed. When correlations turn positive, as they did in 2022, stocks and bonds can decline simultaneously, magnifying portfolio risk. The challenges of 2022 highlighted this dynamic, as Aggregate Bonds not only failed to offset equity losses but amplified risks by declining as much as 18.4%. This shift raises serious doubts about the reliability of traditional diversification strategies, as relying solely on stocks and bonds no longer provides the protection it once did.
In today’s evolving market environment, traditional diversification alone is no longer enough. Redwood’s RiskFirst® approach leverages non-correlated assets across both public and private debt markets, combined with proactive risk mitigation strategies designed to reduce drawdowns and strengthen portfolio resilience.
Rising Correlations, Rising Risks
Sources: Bloomberg, Redwood. Data as of 1/7/2025. For illustration purposes only.
Portfolio Recap
The first half of 2024’s performance was dominated by the larger “Mag 7” companies, but the second half marked a strong finish for the broader market, driven by a shift in leadership and increased participation across equity securities. Redwood’s Engineered Risk-Budgeted strategies benefited from this shift, with our tilt toward smaller-cap stocks and a more equal-weighted approach. Gains in the Russell 2000 and the S&P 500 Equal Weight Index became key contributors to portfolio performance, helping to offset the earlier divergence and driving strong results in the second half of the year.
On the fixed-income side, a modest recovery in bond prices provided some relief, while credit spreads tightened to multi-year lows, benefiting high-yield and other non-core fixed-income asset classes. These gains complemented the strong equity performance, highlighting the value of capturing opportunities across asset classes. Additionally, access to private debt further enhanced portfolio resilience and return potential.
Throughout the year, our disciplined RiskFirst® approach guided portfolio construction. By remaining agile and responsive to shifting momentum, the portfolios maintained a mostly risk-on stance, benefiting from the tailwinds of the second half of 2024. As we move into 2025, our quantitative approach ensures that our strategies remain adaptive and responsive to changing market conditions. This involves identifying and reducing underperforming strategies that no longer offer the same risk-return profile they once did, while reallocating to more attractive opportunities that enhance the portfolio’s overall risk-return balance.
2024 in Review
Sources: Bloomberg, Redwood. Data as of 1/7/2025. For illustration purposes only.
Conclusion
The story of 2024 was one of renewed confidence, with markets delivering strong equity returns and optimism driving momentum. However, history reminds us that prolonged rallies often carry heightened risks. Significant drawdowns can destroy wealth for years-or even decades-leaving lasting impacts that ripple across generations.
The lessons of the past make it clear: avoiding steep drawdowns is essential for preserving and growing long-term wealth. Redwood’s quantitative research ensures portfolios are equipped to navigate volatility while staying grounded in discipline. Although portfolio returns can deviate from the broad markets in the shorterterm, Redwood’s Engineered Risk-Budgeted models are purposefully designed to achieve long-term success and support clients in reaching their financial goals.
Lost Decades
Source: Bloomberg, Redwood. Data as of 10/24/2024. Date range from 10/19/2018 – 10/24/2024. For illustration purposes only.
4th Quarter Market Commentary “From Rally to Reality”
The year 2024 delivered another extraordinary chapter for equity markets. The S&P 500 rallied, fueled by optimism around Federal Reserve rate cuts and cooling inflation, and clarity from the highly anticipated presidential election results. This marked the second consecutive year of gains exceeding 20%. However, prolonged rallies often come with heightened risks, as history reminds us.
The drivers of 2024’s success tell a story of concentrated leadership and elevated valuations, with key metrics surpassing levels last seen during the tech bubble. Fixed-income markets, while stabilizing, offered muted returns as investors grappled with shifting rate expectations and rising correlations.
As we turn to 2025, the risk landscape grows more complex, with historical patterns suggesting heightened volatility ahead. Our RiskFirst® approach remains central to balancing opportunity and caution as we prepare portfolios for what could be a pivotal year.
When Markets Defy Predictions
The S&P 500 surged 25% in 2024, driven by continued optimism around easing inflation and a resilient U.S. economy-signaling what many see as a successful soft landing orchestrated by the Federal Reserve. This remarkable performance far exceeded Wall Street’s projections at the start of the year, as analysts once again failed to anticipate the market’s trajectory. In fact, 2024 marked the fifth consecutive year where economists were unable to predict even the range of the index’s year-end close, highlighting the persistent challenges of forecasting equity markets-even for the most seasoned experts.
Undeterred by their track record, economists have already released their predictions for 2025. Yearend return estimates range from Oppenheimer’s bullish +21% to Cantor Fitzgerald’s more conservative +2%, reflecting optimism amongst these analysts. However, given the consistent inaccuracy of these forecasts, history suggests the market’s path may yet again surprise us.
Another Year, Another Miss
Narrow Leadership
Over the past two years, the S&P 500’s performance has been dominated by a concentrated set of companies, putting the index’s fate in the hands of just a handful of stocks. Since the October 2022 market bottom, the top 10 stocks alone have accounted for 50% of the index’s total return, with the remaining 490 companies contributing the other half. In 2024, the top ten stocks were responsible for over 60% of the S&P 500’s return.
This extreme concentration not only skews performance but amplifies risks for investors reliant on the broader market. For example, Nvidia, the semiconductor powerhouse, has become a major driver of the S&P 500’s growth, representing a disproportionate share of returns and a significant portion of the U.S. economy itself. In fact, the current value of Nvidia alone is over 10% of the entire U.S. GDP (as of 1/24/25).
While concentrated leadership has driven short-term gains, it also increases potential vulnerabilities if these leaders falter. Investors must weigh the opportunities of riding this momentum against the risks of over-reliance on a narrow group of companies.
The Weight of a Few
A Challenging Starting Point
As President Trump begins his term in 2025, he inherits a market with the highest equity valuations ever seen at the start of a presidential administration. The S&P 500’s CAPE ratio-a measure of valuation comparing stock prices to their long-term earnings-now stands at an unprecedented 37.8. Elevated valuations like these reflect strong investor optimism but also leave markets more vulnerable to shifts in policy or economic conditions.
No administration has ever faced such lofty market metrics upon taking office. This creates unique challenges, as decisions made by the incoming administration could have an outsized impact on financial markets, amplifying both risks and opportunities. Historically, periods of elevated valuations have often been followed by heightened market volatility, underscoring the importance of managing downside risks.
Presidents Inheriting High Valuations
Valuations Set the Stage
The expensive nature of today’s equity markets warrants a closer look at how valuations impact long-term returns. In this scatterplot, each dot represents a point in time, comparing the S&P 500’s forward price-to-earnings (P/E) ratio with its subsequent 10-year annualized return. The pattern is clear: when valuations are low, future returns tend to be higher. Conversely, when P/E ratios are high, future returns are typically much lower.
At today’s forward P/E ratio of 25, the S&P 500 sits firmly on the higher end of the valuation spectrum. Historically, similar levels have preceded a decade of lackluster performance, in stark contrast to the robust returns investors have enjoyed recently.
Returns Post P/E
Fixed-Income Frustration
Despite starting the year with attractive yields (4.53% for U.S. Aggregate Bonds and 5.06% for Investment-Grade Corporate Bonds) public fixed-income delivered lackluster total returns for the year. On top of interest and dividends earned, total return also incorporates changes in price. In 2024, bond prices fell as market expectations shifted toward “higher rates for longer,” even with the Fed cutting rates by 100 basis points which under normal circumstances would have boosted current bond values.
The result was that higher yields could not fully offset the drag from declining bond prices, leaving total returns nearly flat. This underwhelming performance has offered little relief for U.S. Aggregate Bonds, which suffered drawdowns of -18.4% in 2022 and, as of the end of 2024, remain in a prolonged decline spanning over four years. For many, these asset classes represent core fixed-income allocations, which is why it is so important to understand the interplay between yield, price, and total performance.
Yields Can’t Save It
Yield Curve Clues
The optimism surrounding Fed rate cuts in 2024 has been tempered by signals from the 2-year Treasury yield. Over the past 25 years, the 2-year Treasury yield has emerged as a surprisingly strong indicator of Federal Reserve policy. While the Fed is often seen as steering the short end of the yield curve, it’s the 2-year yield, which is driven by the market’s expectation of shortterm interest rates over the next two years, that frequently moves first.
This could be a signal for shifts in monetary policy before they happen. This dynamic is playing out again today, with the 2-year yield rising above the Fed Funds Rate-a potential signal that markets expect higher rates or a prolonged period of elevated borrowing costs. As we head into 2025, this divergence between market pricing and central bank policy point to uncertainty surrounding the interest rate landscape.
Ahead of the Fed
Risk After the Rally
After two consecutive years of 20%+ market gains, the road ahead for 2025 may feel uncertain. While recent performance has been exceptional, history suggests that such strong back-to-back gains often give way to increased volatility. As this chart illustrates, years following two consecutive 20%+ market rallies have historically experienced an average maximum drawdown of -23.8%, with some drawdowns exceeding 40%.
While our portfolios remain largely risk-on at present, it’s essential to prepare for the potential challenges 2025 may bring. Managing risk and staying vigilant will be critical in navigating what could be a more turbulent year.
2025 Landscape
History’s Hardest Lessons
The remarkable optimism of 2024 serves as a reminder of how quickly markets can climb-but history also warns of how quickly gains can evaporate. The story of the Nasdaq Composite following the dot-com bubble is a stark example. Following its meteoric rise, the index crashed in the early 2000s, ushering in a “lost decade” that took 15 years to fully recover from. Even worse, between 2000 and 2012, the Nasdaq Composite index delivered annualized returns of -1.5%. This illustrates the long-lasting impact that significant losses can have on portfolios, with years-or more than a decade in this case-needed to claw back gains.
Ignoring these lessons leaves portfolios vulnerable to prolonged setbacks. That’s why a disciplined approach remains essential for navigating potential volatility in 2025, helping to mitigate large drawdowns and protect your financial future.
Decade in the Red
When Bonds Don’t Protect
For those that believe traditional methodologies may be sufficient to navigate the risks ahead, the recent shift in the relationship between stocks and bonds presents a clear challenge. Historically, the correlation between stocks and bonds has been negative, meaning they typically moved in opposite directions. When stocks fell, bonds typically rose-allowing bonds to act as a stabilizer during market downturns. This negative relationship provided reliable diversification and helped reduce overall portfolio risk.
In recent years, this relationship has reversed. When correlations turn positive, as they did in 2022, stocks and bonds can decline simultaneously, magnifying portfolio risk. The challenges of 2022 highlighted this dynamic, as Aggregate Bonds not only failed to offset equity losses but amplified risks by declining as much as 18.4%. This shift raises serious doubts about the reliability of traditional diversification strategies, as relying solely on stocks and bonds no longer provides the protection it once did.
In today’s evolving market environment, traditional diversification alone is no longer enough. Redwood’s RiskFirst® approach leverages non-correlated assets across both public and private debt markets, combined with proactive risk mitigation strategies designed to reduce drawdowns and strengthen portfolio resilience.
Rising Correlations, Rising Risks
Portfolio Recap
The first half of 2024’s performance was dominated by the larger “Mag 7” companies, but the second half marked a strong finish for the broader market, driven by a shift in leadership and increased participation across equity securities. Redwood’s Engineered Risk-Budgeted strategies benefited from this shift, with our tilt toward smaller-cap stocks and a more equal-weighted approach. Gains in the Russell 2000 and the S&P 500 Equal Weight Index became key contributors to portfolio performance, helping to offset the earlier divergence and driving strong results in the second half of the year.
On the fixed-income side, a modest recovery in bond prices provided some relief, while credit spreads tightened to multi-year lows, benefiting high-yield and other non-core fixed-income asset classes. These gains complemented the strong equity performance, highlighting the value of capturing opportunities across asset classes. Additionally, access to private debt further enhanced portfolio resilience and return potential.
Throughout the year, our disciplined RiskFirst® approach guided portfolio construction. By remaining agile and responsive to shifting momentum, the portfolios maintained a mostly risk-on stance, benefiting from the tailwinds of the second half of 2024. As we move into 2025, our quantitative approach ensures that our strategies remain adaptive and responsive to changing market conditions. This involves identifying and reducing underperforming strategies that no longer offer the same risk-return profile they once did, while reallocating to more attractive opportunities that enhance the portfolio’s overall risk-return balance.
2024 in Review
Conclusion
The story of 2024 was one of renewed confidence, with markets delivering strong equity returns and optimism driving momentum. However, history reminds us that prolonged rallies often carry heightened risks. Significant drawdowns can destroy wealth for years-or even decades-leaving lasting impacts that ripple across generations.
The lessons of the past make it clear: avoiding steep drawdowns is essential for preserving and growing long-term wealth. Redwood’s quantitative research ensures portfolios are equipped to navigate volatility while staying grounded in discipline. Although portfolio returns can deviate from the broad markets in the shorterterm, Redwood’s Engineered Risk-Budgeted models are purposefully designed to achieve long-term success and support clients in reaching their financial goals.
Lost Decades
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