Gill Capital Partners 2024 Holiday Update
First and foremost, the team at Gill Capital Partners would like to wish you a very happy holiday season and a peaceful and healthy new year. We are incredibly thankful for all of you and feel fortunate for the amazing relationships we have with our clients, friends, partners, and colleagues.
We are also thankful for a very good year of investment returns, driven by a steadily improving inflation picture and an economy that has, despite a significantly higher interest rate environment, continued to grow above trend and beyond most experts’ expectations. However, as we move into the new year, we grow more cautious for a couple of key reasons: first, the past couple of years have seen above trend-market returns pushing valuations up dramatically, and second, we see the potential for numerous sources of volatility as we move into a new year and new political backdrop. We have updates on the Federal Reserve’s final meeting of the year, along with updates on inflation, jobs, and other fundamental data points. We will also provide some color on our current thinking and some portfolio changes we are making as a result. Before we do, however, an interesting data point on public versus private equity markets:
Did you know that there are fewer public companies today than there were 40 years ago? The universe of public companies has been contracting for a number of reasons, including onerous regulations, cheap capital availability elsewhere, and investor short-termism (the focus on short-term results for private companies).
Many analysts believe we are due for a significant uptick in Initial Public Offerings (IPOs) and more M&A activity in the coming years, as many of these private businesses are looking for big liquidity events.
Fundamentals Update
The two most important economic data points right now are inflation and jobs, and we received monthly updates on both of these recently.
Inflation – The monthly report on consumer prices (CPI) for the month of November came out earlier this month, and it showed that prices rose 2.7% from a year ago and 0.3% for the month. Core CPI, which excludes food and energy prices, increased 0.3% for the month and 3.3% from a year ago. These numbers were largely in line with market expectations and this report further solidified the Fed’s decision to cut interest rates by .25% at the final Federal Reserve meeting of the year.
Our view – This number was largely as expected and gave the Fed the green light to cut interest rates again at their meeting a week later. While inflation is still above the Federal Reserve’s 2% target, significant progress has been made to get the COVID-induced inflation issue back under control. Remember, this does not mean that prices are going down, this simply means that the pace of price increases has slowed back to a more normal range. While the number was mostly as expected, the market did not particularly like the Fed Chairman Jerome Powell’s comments that point to a slower pace of rate cuts in the future (more on that below), as some Fed officials are frustrated with inflation’s resilience, particularly in the housing related components, which have refused to moderate.
Jobs – We also received the monthly non-farm payroll jobs report earlier this month. The report showed that payrolls rose by 227,000 in the month of November, which was slightly better than the estimate of 214,000. October’s jobs report was also revised higher by 36,000 for the month. The unemployment rate edged higher to 4.2%, which was as expected. Finally, worker pay continued to rise, with average hourly earnings up 0.4% from a month ago and up 4% on a 12-month basis, both a bit above expectations.
Our view – This report continues to show a robust employment picture with unemployment well below its long-term average of just over 6% and wage growth hovering near its long-term average. As we have discussed previously, there is a structural labor supply shortage in this country, due largely to demographic trends that have kept the labor market tighter than it otherwise might have been. This is a healthy labor market that has continued to propel consumer spending and power the economy in recent years. What are we watching here? While largely speculation at this point, we will be paying keen attention to the incoming administration’s actions as they relate to Federal Government cuts. The new “Department of Government Efficiency” (DOGE) as laid out has plans for significant cuts to federal departments, which would likely translate to federal worker layoffs. Again, this is largely speculation at this point, but we are keeping our eye on this as a potential driver for short-term unemployment as well as market volatility.
Equity Valuations – U.S. equities have seen two phenomenal back-to-back years of performance, pushing valuations significantly higher. As shown in the chart below, current valuations for stocks in the S&P 500 index are well above their 30-year average.
This picture is further complicated by the makeup of the recent equity rally, which has seen a historic concentration of returns limited to a small group of stocks. This has resulted in market indices having historic levels of concentration in a few companies including Apple, Nvidia, Amazon, etc.
Our view – This is not as simple as it may seem; high valuations do not necessarily mean that stocks are due for an imminent correction, although a normal correction is probably overdue and should be expected as part of a normal market cycle. Valuations can remain elevated for some time and high valuations should not necessarily scare investors. Valuations of some of the best companies, such as Google and Apple, have been high by these standards for decades, and rightfully so, as their earnings growth has continued to remain high. Investors scared off by high valuations have missed significant returns over the years. Furthermore, following the election, there is a reasonably strong likelihood of corporate tax cuts and an extension of the current individual tax rates. Corporate tax cuts would be welcomed by corporate America and would directly impact the bottom line, bringing valuations down as corporate earnings increase. That said, we do believe much of this has already been priced into the current market.
Federal Reserve and Interest Rates
Earlier this month, The Federal Reserve lowered its benchmark rate by a quarter point, taking the Fed’s overnight borrowing rate to a range between 4.25% and 4.50%. Since September, the Fed has reduced its benchmark rate by a full percentage point. The December interest rate cut was widely expected by economists. Changes to the FOMC statement were minimal, but did suggest a slower pace for future rate cuts in 2025 than previously anticipated.
Our view – We believe that the Fed will be cutting rates moving forward, but at a slower rate next year, as economic growth has been stronger than anticipated and inflation has remained stubbornly above their 2% target. Interest rates have moved materially higher following the most recent Fed announcement, as markets are now pricing in the likelihood that this higher rate environment will stick around for a while longer.
Conclusions & Portfolio Updates – While fundamentals are currently very strong, we are cognizant that the past couple years have stretched equity valuations, and that multiple sources of volatility are potentially looming. As such, we are taking a slightly more defensive posture within portfolios by adding back in equity hedging. We are also reducing our allocations to international equities, as many of the incoming administration’s policies appear unfavorable for international investing. We also continue to increase durations within our fixed income portfolios to take advantage of high interest rates. While there remain many positive drivers for equities, namely AI, corporate profits, and strong consumer spending, we do feel moving to a slightly more defensive posture is rational here.
Financial Planning Corner – Custodial Roth IRAs – Did you know that if your child has earned income, you can establish a custodial Roth IRA to help them towards their retirement goals? Many clients wish they started saving for retirement years earlier; this can be a way to help your children gain an additional decade or two of compounding growth in the markets. Custodial Roth IRA accounts are after-tax accounts that grow tax-deferred, and withdrawals are tax-free in the future (if all the rules are properly followed).
These types of accounts are only available for children who have earned income (generally achieved through part-time work). Business owner clients may consider having their children work within their own business. The contribution limit for a Roth IRA in 2024 (and in 2025) is the lesser of $7,000 or your child’s total compensation for the year. These retirement accounts are flexible, not requiring an annual contribution, and contributions can be withdrawn anytime. Some parents implement a “matching” program to help their child better fund the custodial Roth IRA up to their full contribution amount or their full earned income for the year. The parent is able to help direct the investments while their child is a minor, and the child will become responsible for this account when they reach age 18 (or age 21, depending on the state). The deadline for establishing and funding a custodial Roth IRA for 2024 is April 15, 2025, so there is still time to get this set up if your child had earned income in 2024.
Note that the balances of retirement accounts are not included in calculating federal financial aid. If you have any questions about funding a custodial Roth IRA, please get in touch with your advisor. The custodial Roth IRA can be a great way to help children start to learn about the importance of investing and instill good money habits for their financial future.
We Have Moved!
We are excited to announce we have officially moved to our new location! Our new office is located in South Denver at 4582 S. Ulster Street, Suite 1400 Denver, CO 80237. It has been carefully designed to ensure a comfortable and accessible environment for our clients and team members, and we hope you enjoy it! We can’t wait for you to see our new space!
We hope everyone has a wonderful, safe, and healthy new year. Cheers!
As always, please let us know if you have any questions or concerns, or if we can provide assistance with any other financial planning matters including education, taxes, insurance or estate needs.