Financial markets entered the new year as if they had ended the old year, and headed upwards. The stock rose during the first trading session of January, continuing a trend that lasted through much of last year.
The situation remained favorable throughout the previous year. Excitement over artificial intelligence, falling inflation, and central bank intervention continued to rise. Trade wars, global tensions and soaring stock prices? Investors ignored them. The bottom line was very simple: taking risks paid off.
But it wasn't just the profits themselves that really stood out. That's how everything came together. Stocks have gone up. Bonds went up. Credit spreads narrowed. Commodities rose even as inflation cooled. Benefits came from all directions and continued to accrue. By the end of the year, financial conditions had eased to a level close to the easiest for the year. Stock valuations have risen, and investors seem to agree on economic growth and AI as its driving forces.
Looking at global stocks, bonds, credits and commodities as one big picture, last year delivered the best overall performance since 2009. That was a year when the market was in crisis mode and the government had to take major action.
All of this together has made diversification seem all too easy. Actually, that's the problem. It concealed how much it depended on the continuation of the same conditions. If your investments that are supposed to offset each other all go in the same direction, you won't be as protected as you think. Indeed, the returns add up. But there is less room for things to go wrong.
Wall Street is still betting on the same strategy
Wall Street analysts are still counting on the same things: massive AI spending, solid economic growth, and central banks cutting interest rates without reigniting inflation. Forecasts from more than 60 companies show fairly broad agreement that these conditions remain in place.
The problem is that there is already a lot of good news in the market.
“We assume that the breakneck pace of valuation growth we've seen in some sectors is neither sustainable nor repeatable,” said Carl Kaufmann, a portfolio manager at Osterweiss, regarding AI and nuclear stocks. “While we are cautiously optimistic that a major collapse can be avoided, we are concerned that future returns may be poor.”
The numbers speak for themselves. U.S. stocks returned about 18%, marking the third consecutive year of double-digit gains. Global stocks fared even better at about 23%. Government bonds also rose, with global U.S. Treasuries rising nearly 7% as the Federal Reserve cut interest rates three times.
Volatility has fallen significantly, and credit markets have followed suit. Bond market volatility recorded its biggest annual decline since the financial crisis. Investment-grade spreads have narrowed for the third year in a row, with average risk premiums below 80 basis points.
Commodities have also joined the movement. The Bloomberg index, which tracks the sector, rose about 11%, led by precious metals. Supported by central bank purchases, easy monetary policy in the United States, and a weak dollar, gold has hit record highs one after another.
Inflation remains a wild card that can turn everything upside down
Inflation remains a big wildcard. Price pressures eased through most of last year, but some investors warn that the situation could quickly reverse due to energy market or policy mistakes.
“The key risk for us is whether inflation ultimately picks up,” Schroders' Mina Krishnan told Bloomberg. “While we envision a domino of events that could lead to inflation, we believe the most likely path starts with rising energy prices.”
We see a disconnect that goes beyond just the market. As previously reported by Cryptopolitan, the world's 500 richest people increased their wealth by a record $2.2 trillion last year. Meanwhile, consumer confidence in the United States declined for five consecutive months through December.
Old-fashioned Wall Street strategy has also made a comeback. A 60/40 portfolio that splits money between stocks and bonds returned 14%. The index based on risk parity strategies rose 19%, its best year since 2020.
Most investment managers still don't realize it. They argue that economic momentum and policy support are strong enough to justify rising prices.
“We want to deploy as much cash as possible to take advantage of the current environment,” said Josh Kutin, head of North American asset allocation at Columbia Threadneedle Investments. “We don't really see any evidence that we should be worried about an economic downturn in the near term.”
