FIRST QUARTER INSIGHTS – January 31, 2025
PERCEPTIONS – From uncertainty to opportunity: a 2024 market recap and 2025 outlook
by LESLIE CALHOUN, Senior Partner and CEO and RYAN THOMASON, CFA, Portfolio Manager
2024 was a year that defied expectations. Global economic growth diverged amidst elevated uncertainty, nearly half of the world’s population participated in elections, inflation eased across major economies, and risk assets performed well. The four major themes that emerged from 2024 were:
- US Exceptionalism: At the start of 2024, analysts and economists predicted that US growth would normalize. Instead, the US economy surprised to the upside. This was driven by resilient consumer spending and AI-driven investment.
- Developed Economies Rate Cuts: 2024 was supposed to be the year of bonds, as markets anticipated multiple rate cuts across developed markets. Although rate cuts occurred, they did not drop as much as expected. Stubborn inflation and stronger than expected growth pushed US long rates higher while hawkishly shifting rate expectations for 2025.
- Gold and the Dollar: Safe-haven assets performed strongly in 2024. Gold climbed 27% amid record central bank purchases while the US dollar appreciated 7% thanks to macro conditions that included strong US growth, high US yields, and geopolitical uncertainty.
- Risk Assets: Despite expectations of normalized growth in early 2024, US equities once again defied expectations, posting a second consecutive year of 20%+ returns. This has only happened four times since the 1930s. As in 2023, these returns were driven by large-cap companies, fueled by strong earnings, optimism around AI, and potential deregulation under the new Trump administration. Outside the US, European equities struggled alongside a weakening economy while Japanese and emerging markets fared better, especially from Taiwan and India.
Portfolio Insights
As we enter 2025, our portfolios reflect a pro-growth outlook and a strong preference for US assets. We expect a pro-growth economic policy to extend the business cycle in 2025.
- Equities: We expect US exceptionalism to continue and are therefore overweight in US equities. US large cap companies continue to have high quality and strong earnings but valuations, especially in technology, are a headwind. Given the higher-than-normal valuations, we have begun expanding into mid-cap and small-cap. These companies should continue to benefit from decreasing interest rates and disinflation while also adding diversification benefits to portfolios. We continue to underweight Europe as they face subdued growth forecasts, uneven inflation across the region, and the potential for tariffs which could add further strain to growth. Lastly, we remain neutral on emerging markets (excluding China) but have an overweight to Indian equities. India continues to be a benefactor from favorable demographics, accelerating urbanization and digitization, and political and economic reforms.
- Fixed Income: We continue to favor mid-to-low credit quality over long duration assets, given the resilience of corporate balance sheets, low distress ratios, and persistent strong demand for new issues. This has led us to overweight private credit and floating-rate bonds. After witnessing the strong rally in credit spreads, real estate lending continues to be an attractive area as well. We prefer taking a preferred equity position in the capital stack to benefit from higher yields while feeling protected by sufficient equity to support any decrease in asset values.
- Alternatives: Within real estate, we continue to focus on the shortage of affordable housing by investing in projects through equity or preferred equity, depending on the return objectives. Data centers, specifically co-location properties, are also of interest due to the ongoing demand for AI, cloud computing, and internet-of-things (IoT) applications. We believe the recent news and stock market volatility around DeepSeek has been overblown. There are more questions than answers at this point. However, our initial thoughts are that even if it becomes cheaper to run AI models moving forward, the demand for AI will remain strong. Jevon’s paradox suggests that as technological progress increases the efficiency of a resource, the rate of consumption of that resource increases rather than decreases. If running AI models and advancing AI capabilities becomes cheaper, we can do more with it. We anticipate an acceleration in AI usage demand because it will be more cost-effective for society as a whole. Life settlements continue to offer little to no correlation with public markets, acting as an uncorrelated diversifier for portfolios. Lastly, we are exploring various investment opportunities within private equity as more and more companies choose to remain private for longer periods.
Our portfolios are designed to benefit from an extension of the business cycle and a continuation of US leadership. As the policy priorities of the new administration become clearer over the first half of the year, markets may be tested at times, but our well-diversified portfolios and extensive use of low-to-no correlated alternatives should serve as a ballast through market volatility.
The Case for Converting IRA Assets to Roth IRAs
by MATT McMANUS, Partner and COO
As the new inherited IRA rules prompt many to rethink their estate planning strategies, converting traditional IRA assets into Roth IRA assets is gaining importance. Roth IRAs provide several advantages that can help mitigate the impact of the new tax rules:
1. Tax-Free Withdrawals for Beneficiaries
When an IRA is converted into a Roth IRA, the original account holder pays taxes on the conversion in the year it occurs. However, once the funds are in the Roth IRA, all qualified withdrawals are tax-free. This can provide significant benefits for beneficiaries, who, under the SECURE Act, must take distributions from inherited IRAs. If the IRA is converted to a Roth IRA before the account holder’s death, the inherited Roth IRA will allow beneficiaries to take tax-free withdrawals (subject to the 10-year rule). This can provide an efficient way to transfer wealth without adding a tax burden to the recipient.
2. Avoiding Required Minimum Distributions (RMDs)
Traditional IRAs require RMDs starting at age 73 (as of 2024). Roth IRAs, on the other hand, are not subject to RMDs during the account holder’s lifetime. This allows individuals to let their funds grow tax-deferred for a longer period, creating more opportunity for wealth accumulation. Though the SECURE Act still requires inherited Roth IRAs to be emptied within 10 years, they will not be subject to income tax, making them an attractive option for beneficiaries.
3. Potential for Lower Tax Rates
Converting traditional IRA assets to a Roth IRA can be a smart strategy if you expect to be in a higher tax bracket in the future, or if you anticipate that taxes on retirement income may increase. By paying taxes at today’s lower rates, you lock in the tax rate on your converted assets. This can help minimize the overall tax burden in retirement and provide more flexibility for managing income in your later years.
4. Estate Planning Benefits
Roth IRAs are not only beneficial to the account holder but also offer substantial advantages in estate planning. Since Roth IRAs are not subject to RMDs during the account holder’s lifetime, they can continue to grow tax-free for a longer period. Furthermore, when passed to beneficiaries, the tax-free growth continues, making Roth IRAs an effective tool for passing on wealth to the next generation with minimal tax consequences.
Strategies for Converting IRA Assets to Roth IRAs
While converting traditional IRA assets to Roth IRAs can be a powerful strategy, it requires careful planning to avoid unnecessary tax consequences. Here are a few strategies to consider:
- Partial Conversions: Instead of converting the entire IRA balance in one year, consider doing partial conversions over several years. This can help spread out the tax liability and avoid bumping yourself into a higher tax bracket in any given year.
- Timing the Conversion: If you anticipate a year with lower income, such as after retirement or during a gap between jobs, it may be an ideal time to convert some of your IRA assets to a Roth IRA.
- Strategic Planning for Beneficiaries: Consider how your beneficiaries will be impacted by the new 10-year rule for inherited IRAs. If you anticipate that your heirs will be in a higher tax bracket, converting your IRA to a Roth may be a smart way to reduce their tax burden.
Conclusion
The changes to inherited IRA rules introduced by the SECURE Act represent a fundamental shift in retirement and estate planning. While the new 10-year rule provides beneficiaries with more flexibility, it also increases the tax burden on inherited IRA assets. One of the most effective ways to mitigate this burden is by converting traditional IRA assets to Roth IRAs. By doing so, you can provide tax-free withdrawals for both yourself and your beneficiaries, avoid required minimum distributions, and create long-term tax advantages. Converting to a Roth IRA is an important strategy that can help ensure your retirement assets are passed on to your heirs in the most tax-efficient manner possible.
As always, it’s advisable to consult with us in conjunction with your tax professional to evaluate the best course of action based on your specific financial situation and goals.
Respectfully,
Leslie, Matt, Ryan & Ashlee