January Newsletter 2025
January 3, 2025
“Trees Don’t Grow to the Sky”
Dear Client:
The books on 2024 have been closed, with remarkable portfolio returns from all things technology and AI for the second year in a row, as measured by the performance of the Domestic Equity Portfolio category. The S&P 500 US stock index notched annual returns of more than twenty percent in consecutive years for the first time since 1997 and 1998 (just prior to the dot-com bubble). Our broadly diversified Domestic Portfolio of large, mid and small-cap equities returned twenty percent (before management fees) in 2023 and reached 22.75 percent (before fees) on November 9th, before retracting on the heels of Fed Chairman Powell’s remarks about future Fed moves to lighten the burden and taking a pause; only to close the year at a return of just under nineteen percent. Sky high equity valuations also prompted many investors to take some profits “off the table” to give the enthusiasts a chance to catch a breather and wait and see if the expected 2025 company profits justified the high valuations.
Using the Wheeldon Retirement Portfolio as a proxy for all managed accounts, Laura has prepared the graphic on the left to illustrate the volatile performance track for 2024. Not surprisingly, the steep ups and downs of the track reflect the various economic and geo-political news cycles which drive the underlying market algorithms that permeate many of the trading platforms used by the index funds that have become so popular. The gyrations are annoying, but they do give rise to the opportunities built in to our “buy low, sell high” strategy. We deftly employed our “sell high” strategy in November and redeployed the harvest into other portfolio categories that needed rebalancing (including the bond ladder for clients in distribution). Most managed portfolios include domestic equity allocations of twenty-five to thirty percent of the total managed portfolio. Our multi-category portfolio allocation strategy is built on the proven investment management principle of non-correlated investments that both buffer wild market swings and even out the long-term total portfolio track to reduce the risks of investing in only one asset class.
The Alternative Equity category (invested primarily in real estate and energy securities) returned muted 2024 returns primarily due to the effects of higher interest rates throughout most of the year and volatile prices of energy impacted by both domestic and political energy policies. The graphic to the left highlights the impact of Powell’s remarks, where the category hit a high of over nine percent in November, only to fall in December. It should be noted that this category earns annual cash dividends of over three percent, providing much needed cash inflows for both reinvestment and distribution to clients. We are expecting this category to produce more consistent returns in 2025 as interest rates which impact real estate valuations are expected to stabilize. We also expect the positions devoted to the energy needed to fuel the growing utilization of the new AI applications to produce meaningful returns for many years going forward.
Moving on to the Income portion of the total managed portfolio, the Bonds and CD ten-year ladder saw “new life” in 2024 after the Fed eased its policies and lowered interest rates for the first time in many years, as inflation settled into an acceptable range. The graphic on the left reflects returns of over five percent through November, then declining to just under five percent in December after Powell pulled back on the reins. Nevertheless, the portfolio continues to produce interest income in the four percent range AND continued “guaranteed” maturities over the next ten years to fund planned-for withdrawals for all clients “in distribution”. Most clients have bond ladders totaling twenty-five percent, or more, of their total managed portfolio.
Balancing out the total portfolio, the Alternative Income allocation returned almost twenty-two percent on the year, after peaking in November at over thirty percent. Underlying this category of primarily utility and infrastructure securities is a dividend powerhouse, currently paying over seven percent annually. The growth in values in the category comes from current and expected new energy and infrastructure expansion to power the growth in the economy expected from the AI applications by all businesses and new bitcoin mining operations. Except for the decline in December, the graphic reflects a more gradual and even growth pattern than the two equity graphics above.
Taken together, the enclosed Portfolio Review for your managed portfolio reports the overall (net of management fees) bottom-line returns for the One-Year, Five-Year and Ten-Year periods of our management.
Looking ahead to 2025, we do see a resilient US economy and a Fed that is willing to cut interest rates (even if at a slower pace than once thought). The combination should allow US equity values to continue their upward trend. That being said, remember that Jack Bogle (Vanguard’s founder and leader for many decades) was often quoted as saying “Trees don’t grow to the skies.” And, the S&P 500 has never recorded annual returns in excess of twenty percent in any three consecutive years. We firmly believe that we need to be realistic and remember that NO TREE GROWS TO THE SKY! However, we believe that the Magnificent Seven that drove the S&P skyward in ’23 and ’24 cannot possibly produce the year-over-year growth which has propelled those stocks into the stratosphere. Many market commentators (including James and me at IIM) are of the mind that the expected economic growth in ’25 will favor the 493 other companies in the S&P and the many small and mid-cap companies included in our Domestic Equity and other portfolio allocations. Such a broadening of the market participation will be a welcome sight and underlies our basic belief in the power of broad diversification across market classifications and industries, with expectations of historically more moderate market returns.
During 2024 as the securities markets climbed to all-time highs, the digital currency phenomenon took off, with Bitcoin soaring in value to a high of over $108,000 in December, for a gain of roughly 150 percent over the prior year; with a current valuation of under $100,000. The surge in value gained momentum from the results of the presidential election. Many Bitcoin speculators have taken the President elect’s promise to create a Strategic Bitcoin Reserve as an indication that digital currencies will be adopted by and regulated by the US government. Speculators have concluded that investing in digital currencies as a hedge against the diminishing value of the US dollar will provide long-term security, just as buying gold and silver was viewed during the financial crisis.
Readers of my letters over the past years will remember me pointedly writing that we would never invest our client’s hard-earned savings in an investment that did not meet our three-point criteria:
- The investment must generate current revenue.
- There must be bottom line profit.
- It must pay dividends back to our clients.
Those comments came from our observations of the collapse of the equity markets during the Dot.com era. Our conclusions were also based on the seventeenth century “Tulip Mania”, where the irrational exuberance and speculative mania resulted in significant financial losses when the Tulip market sentiment shifted. That early example of an economic bubble serves as a cautionary tale embraced by educated financial advisors. Investing in Tulips did not meet our three-point investment criteria and neither does Bitcoin. James has gone to each of our Domestic Portfolio fund managers to determine if any of the funds in our portfolio have any current exposure to digital currencies; none have.
Over the last year or so several clients have come to us asking our opinion about investing in digital currencies. Our response has been that the fund managers we invest with, as well as our professional standards, have dictated to us that such investments are too speculative to meet our more conservative, tried and true guidelines. Nevertheless, both our custodian Charles Schwab and several well recognized money managers have opened the door to making such investments. There are currently three generally recognized avenues for buying and owning Bitcoin. Of the three options for ownership, Bitcoin ETFs provide a custodial option for clients to make such investments.
James has actively explored the practical aspect of offering digital currency exposure in our portfolio. Investing in cryptocurrency can at first glance offer appealing rewards due to large upward fluctuations, but these upward rewards come with considerable risk, because what goes up, also goes down. A small allocation to digital assets (one percent or less), might be suitable for some clients, who can pass the “sleep at night” test and stand the risk of losing these invested funds.
The best practice of fiduciary investment advisors dictates that we would only consider this for client portfolios on a case-by-case basis including an in-person meeting. We would scrutinize the associated risks and evaluate their suitability considering the client’s unique financial background, and their established goals and financial objectives.
Additionally, we would need to sign disclosure documents and update your Investment Policy Statement to reflect any new investments added to your portfolio. Please contact James if this is a topic you would like to discuss further. Rest assured, we are keeping an eye on this type of investment, and we will continue to evaluate not only its significance but also the prudent level of inclusion in various portfolio allocations for individual clients who feel they must have such exposure.
Come the end of each calendar year we focus on IRA required minimum distributions (RMDs) for the upcoming year. RMDs are now calculated for each IRA account. These calculations apply to all traditional IRAs, SEP IRAs, Simples and 401-k plans. In general, there will be increases in the distribution amounts, as the markets ended the year with higher values compared to the previous year. We will evaluate and call all clients affected to discuss the changes.
With the expectation that the Tax Cuts and Jobs Act of 2017 will be made permanent, it could make sense to both increase annual withdrawals and possibly stop adding to tax deferred retirement accounts. The essence of this thinking is that future withdrawals from growing retirement accounts could be taxed at higher ordinary income tax rates compared to taxes from growth in taxable accounts which are subject to lower capital gains tax rates. This thinking also makes Roth IRAs and Roth conversions more attractive. These thoughts should be discussed with your tax advisor to determine if this strategy makes sense for you.
The horrific events of early morning New Year’s Day in New Orleans and then later in Las Vegas shook our nation to the core of our sensibilities and morals. As our thoughts and prayers are with all those affected, we must as a nation focus on combatting the evils of terrorism that are threatening our way of life. As 2025 unfolds we need to support all efforts at all levels to make our great country safer and promising for our children and grandchildren. Our wish for all of you is a safe, happy and prosperous New year; and the peace that comes with that.
Sincerely,
Intelligent Investment Management, LLP
G. Stephen Wheeldon 
