Category: Market Commentary

Opportunity Ahead: Growing Your Portfolio in 2025

Last year was excellent for the U.S. market, with stocks up 25% after increasing 26% in 2023. It was an outstanding performance compared to international stocks that struggled during the year due to the rising dollar. The 2024 market was largely driven by major technology companies, including Amazon, Facebook, Tesla, and Google, together known as the “Magnificent Seven.” However, while stocks soared, bonds struggled amid rising interest rates. As we look ahead to 2025, the U.S. financial market offers a mix of optimism and cautious planning. 

Economic Outlook for 2025 

This year, the U.S. economy remains uncertain. The Federal Open Market (FOMC) predicts the GDP will slow from 2.5% to 2.1%, with inflation expected to decline as well. Plus, policy changes under the Trump administration may add another layer of uncertainty for the U.S. economy, such as the potential growth of federal debt. By understanding key market trends and taking proactive steps, Brown Financial Advisory can help better position portfolios for growth as we navigate potential uncertainty in 2025. 

Portfolio Positioning

• Bonds are Back: After years of low returns, bonds now offer some of the most compelling opportunities than they have in several years. With significantly higher yields, bonds can be a foundation for stability and growth. If interest rates go down, they could yield significant returns, and even if interest rates rise, bonds still won’t lose much value. 
• Small Companies Offer Big Potential: While smaller companies, or “small-caps,” have faced challenges in the past few years, 2025 could be their time to shine. Earnings for small-caps are projected to grow by 44% this year due to improving economic conditions. 
• Diversification Matters: This year, large U.S. companies, or “large-caps,” including the “Magnificent Seven,” will continue to drive much of the U.S. market’s growth. In fact, in 2024, these companies accounted for 55% of the S&P 500’s annual return, collectively delivering a remarkable 48% return for the year. Without their contribution, the S&P 500 would have gained only 10%. However, these stocks are expensive, with little room for growth. Diversifying your portfolio and investing into small companies (“small-caps”), international stocks, and bonds can balance it and reduce risk.

We see a favorable outlook for portfolios looking ahead to our Brown Financial Advisory 5-10 Year Asset Class and Model Return. While the economy is expected to grow, inflation and interest rates remain uncertain. At Brown Financial Advisory, we can help you navigate potential volatility and uncertainty. For a deeper breakdown of our economic outlook, watch the video below. 

We remain optimistic about the 2025 economy and want to help you be proactive in your financial planning. Learn more about our Investment Management Philosophy and common sense approach to maximizing your portfolio. If you have any questions, please contact us. We’d love to hear from you. 

Time For Cooler Weather, Falling Leaves, And—Capital Gains Distributions?

We are familiar with the adage, “Nothing is certain in life except death and taxes.” Your BFA investment committee understands that it is not what you save; it is what you keep. We have a system to minimize taxes in our client portfolios when possible. Our process includes reviewing tax efficiency when selecting our recommended investments, using asset location rules in portfolios, and assessing/minimizing our clients’ exposure to year-end capital gains distributions. (Mutual funds are required to distribute their realized capital gains by year-end.)

While it is important to never “let the tax tail wag the dog,” we consider an investment’s tax efficiency when we do our due diligence on our recommended securities. We review such statistics as the turnover ratio (the percentage of fund assets replaced in one year) and the tax cost ratio (how much taxes have consumed those percentages of investors’ assets over a trailing time period). We also consider the type of investment. For example, exchange-traded funds (ETFs), particularly those that index, are known for their tax-efficient structure, including not paying year-end capital gains distributions. Unfortunately, sometimes no suitable ETFs are available for our use in an asset class.

Asset location, or the decision of which securities should be placed in tax-deferred accounts and which in taxable accounts to maximize after-tax returns, is a crucial part of our strategy. For example, bonds and other fixed-income investments, which generate most of their returns in ordinary income, should be held in tax-deferred accounts.Now that fall has arrived, our focus turns to year-end capital gains distributions from mutual funds. Research from Russell Investments (see Figure 1) has shown market performance has no relationship to capital gains distributions, which can be short- and long-term. In fact, material (i.e., 5% or more of net asset value) capital gains distributions can happen in years when the stock market is down, which last occurred in 2022.

We review estimates of capital gains distributions as they become available and determine which are material. If it is a recommended fund, we can hold off on buying it until after the distribution. We can also sell those positions where it makes sense to recognize the built-up capital gains rather than take the distribution. Finally, we can do tax-loss harvesting, where we identify positions in taxable accounts that have a capital loss and swap out of those positions for 30 days. Capital losses offset capital gains and $3,000 of ordinary income in the current year and can be carried forward indefinitely for federal tax purposes.

While taxes may be inevitable, proactive planning and management can help make a significant difference. We stay committed to protecting your portfolio’s growth and helping to minimize undue tax liabilities year-round. Through thoughtful asset location, our selection process, and continually monitoring tax implications, we aim to help you navigate year-end capital gains distributions efficiently.  

Explore how we address timely tax considerations using our ongoing True Planning Cycle. Please contact us anytime if you’d like to discuss your situation and needs more in-depth.

Do Presidential Elections Affect The Markets Over The Long Term?

In a U.S. presidential election year like 2024, headlines regarding who is leading in the polls or how a candidate fared in the latest debate tend to dominate the news cycle. Investors often equate controversy with swings in the investment markets, particularly during the primaries. Still, history indicates markets continue to grow over the long term regardless of who sits in the Oval Office. Figures 1 and 2 are courtesy of Capital Group. Figure 1 shows the 10-year growth of a hypothetical $10,000 invested in the S&P 500 at the start of each election year since 1936, with blue bars representing a Democrat winning the presidency and red bars showing a Republican as the victor at the beginning of the 10 years. Except for the 2000s, which saw the dot-com bust and global financial crisis, every 10-year period has seen growth in the S&P 500. And while growth has been somewhat higher under a Democratic president, it has averaged over 10% regardless of the president’s political affiliation.

Finally, while we use broader-market proxies for our U.S. investing and do not focus on sectors of the U.S. economy, it is interesting to see what industries would benefit if there were a blue or red wave (i.e., one party taking over the presidency as well as both houses of Congress). A Republican sweep, or red wave, could benefit banks, healthcare providers, and oil and gas companies, primarily through deregulation. A Democratic sweep, or blue wave, could boost renewable energy initiatives, industrial stimulus spending, and telecommunications projects through additional funding for nationwide broadband access.    

At Brown Financial, our investment philosophy centers on time-tested strategies that prioritize consistency rather than reacting to external influences or shifts. By continuously monitoring the markets and your portfolio, we can identify opportunities when they arise and make thoughtful adjustments to enhance returns, even during periods of uncertainty. Learn more about how our common-sense approach to investing may be able to help you achieve long-term financial outcomes.

Figure 1

Figure 2

A Global Perspective, Part Two

In last quarter’s commentary, we discussed how challenging it is to forecast which country’s stock market will outperform by looking at past returns but noted our client portfolios are allocated across the globe in bonds and stocks to potentially capture higher returns where they appear. Not only does the sheer number of overseas stocks broaden the investing landscape for our clients but they also offer the opportunity for factor investing, or focusing on those types of companies history has shown are persistent drivers of returns, such as Smaller Companies and Value. (Value stocks are shares of a company that appears to trade at a lower price relative to its fundamentals.)

The international funds in our client portfolios have benefited from these international factor exposures. Given the recent headline-grabbing performance of Large-Capitalization Growth stocks in the technology sector, investors can often overlook the strides Value and Small-Capitalization stocks have made during the past three years. Figures 1 and 2 are courtesy of Dimensional Fund Advisors, pioneers in factor investing, and show by region the one- and three-year performance differences of Value minus Growth stocks and Small-Capitalization minus Large-Capitalization stocks. Factor investing, particularly Value, was successful in overseas stocks during both time frames. Additionally, emerging market stocks had the largest margins of outperformance.   

The benefits of global diversification and factor investing may offer a valuable opportunity to help enhance your investment strategy. 

Figure 1

Figure 2

At Brown Financial, our approach emphasizes the importance of global allocation and factor-based strategies that have demonstrated resilience to help our clients pursue long-term financial success. Learn more about our investment philosophy and how it may be able to benefit your portfolio.

Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission. Consider the investment objectives, risks, and charges and expenses of the Dimensional funds carefully before investing. For this and other information about the Dimensional funds, please read the prospectus carefully before investing. Prospectuses and returns current to the most recent month-end are available from Dimensional at (512) 306-7400 or by visiting www.dimensional.com.

Selection of funds, indices and time periods presented chosen by advisor. Fama/French indices used for Value vs Growth are: US Large Value, US Growth, Intl Value, Intl Growth, EM Value, and EM Growth. Indices used for Small vs Large are: Dimensional US Small Cap, S&P 500, Dimensional Intl Small Cap, MSCI World ex USA Growth, Dimensional EM Small, and MSCI EM.

Performance for periods greater than one year are annualized unless specified otherwise. Indices are not available for direct investment and performance does not reflect expenses of an actual portfolio. Performance data shown represents past performance. Past performance is no guarantee of future results and current performance may be higher or lower than the performance shown. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Average annual total returns include reinvestment of dividends and capital gains. Mutual funds distributed by DFA Securities LLC.

A Global Perspective

Given the yo-yo returns we have seen over the past couple of years (U.S. large-cap stocks -18% in 2022/+26% in 2023, foreign developed stocks -14% in 2022/+19% in 2023, U.S. core bonds -13% in 2022/+6% in 2023, etc.), our clients can be forgiven for any resulting dizziness. History shows, however, that global investment returns can change dramatically from year to year, especially in the equity markets and by country. As our friends at Dimensional Fund Advisors (DFA) point out, “Investment opportunities exist all around the globe, but the randomness of global stock returns makes it exceedingly difficult to figure out which markets are likely to be outperformers.” Put another way, it is very challenging to forecast which country’s stock market will outperform by looking at past returns. Exhibit 1 from DFA shows the performance of 22 developed markets since 2003. (Each color represents a different country, and each column is sorted top down, from the highest-performing country to the lowest.) As you can see, over the past 20 years there has been no consistent “leader.” New Zealand posted the highest developed markets return in 2019—but the lowest in 2021. The U.S. ranked in the top five for annualized returns over the entire 20 years but finished first in the country rankings just once over that period. In nine calendar years, it was in the lower half of performers. The good news is our clients don’t have to worry about which countries will deliver the best returns in the future. Our client portfolios are allocated across the globe in bonds and stocks to potentially capture higher returns where they appear. Outperformance in one market can help offset lower returns elsewhere, helping to provide more reliable outcomes over time.

Exhibit 1 disclosures: In USD. MSCI country indices (net dividends) for each country listed. Does not include Israel, which MSCI classified as an emerging market prior to May 2010. MSCI data © MSCI 2023, all rights reserved. Past performance is not a guarantee of future results.

Is this time different?

We are sometimes asked after a market downturn, “Is this time different?” While the answer historically has always been “No,” it certainly feels like a “Yes” this time, given the struggles in the stock and bond markets ever since the Federal Reserve started raising the federal funds rate in March 2022. Year-to-date through early October 2023, U.S. stocks (S&P 500) are up over 14% but are not back to their recent high. U.S. core bonds are down over 2% and have never had a third straight year of losses. Why is this? Figure 1 shows only one calendar year going back to 1977 when both U.S. stocks and bonds declined, and that was 2022. BFA clients are not alone in struggling to shake off that year, as every investor with stocks and bonds in their portfolios (the vast majority) is in the same situation.

The good news is that brighter days should be ahead, which could benefit BFA clients. For example, Figure 2 shows our recommended Core Plus bond fund is set up to possibly earn over 13% if the federal funds rate drops by 1%. Most analysts and even the Federal Reserve are forecasting rate decreases this year.

Finally, many investors are tempted to view Treasury bills, CDs, and money market mutual funds as bond replacements, given the higher yields they are currently paying. However, as rates come down, those short-term yields will decrease, and stocks, bonds, and a balanced portfolio should rebound over the next one- and five-year periods. (See Figure 3)