2024 was a strong year for markets. 2025 will be a year of different as the changing of the guards occurs and President Trump implements his policies. While the economy remains on somewhat stable footing, a lot of risks remain, and the country’s fiscal position can quickly get us into trouble. We do not think any of these risks are accounted for in equity or credit market valuations today, which has kept us defensively positioned.

We would describe the current environment as strange and bifurcated, marked by significant disparities in the health and strength of consumers, companies, sectors, and countries. Despite considerable uncertainty, the market has continued to reach new highs. In this letter, we will explore the components of the Gross Domestic Product (GDP) equation, the upcoming election, government debt, and market trends.

• Central Banks face complex decisions regarding inflation, economic growth, and financial stability in the post-pandemic economic landscape.

• Government spending has significantly contributed to GDP and employment growth but has also led to a high U.S. budget deficit.

• The convergence of slowing demographic growth, deglobalization, and massive debt accumulation may further slow future potential GDP growth.

• The forty-year era of falling bond yields has likely ended, signaling a shift in the economic landscape with higher interest rates and increased borrowing costs.

• The market is expensive, even when removing the impact of the largest capitalization names from the benchmark.

2024 has been full of surprises. The economic data releases have remained robust, surpassing forecasts and, coupled with central banks’ dovish stances, have ignited the S&P 500 to its best first-quarter performance in half a decade. It seemed like the ‘Fed Put’ was resurfacing. While this looks like it could still be the case for many countries, the United States has found itself charting a divergent course in recent weeks.

The fourth quarter was a wild ride. The summer correction continued through late October when the market became fixated on the potential for central banks to begin cutting rates as inflation cooled. In the United States (US), investors priced in an expectation of six rate cuts for 2024, leading to a substantial shift in the anticipated 2024 year-end Federal Reserve (Fed) funds rate—dropping from 4.54% in mid-October to 3.88% at the end of 2023. Concerns related to the global debt burden seemingly dissipated and bonds came roaring back. Treasury Secretary Janet Yellen played a pivotal role by modifying the Treasury's auction strategy, selling more Treasury bills, and decelerating the sales of 10- and 30-year Treasury bonds following disappointing auctions. This was well-timed given the potential for the Fed to begin cutting rates in the next year. If all goes well, they will be able to roll the T-bills into longer-term Treasuries at lower yields. We do not believe the market will get its six rate cuts without a meaningful recession, though the three being signaled by the Fed may be reasonable.