Real Assets Insights: Q4 2024 Real Assets Stumble Into Year-End

Real assets strategy finished lower in the quarter but is poised to benefit from sticky inflation, a positive economic environment, and geopolitical uncertainty.

Global economic activity expanded further in the fourth quarter, closing 2024 on a high note as strong growth in service sector activity offset manufacturing weakness. The United States (US) outperformed other regions, while much of the rest of the world, including Europe and China, continued to struggle. Inflation ticked higher in major developed economies, sitting above central banks’ targets, while unemployment rates remained at or near historical lows.

The year 2024 proved to be a strong year for risky assets, buoyed by robust earnings growth, AI-driven trades, and easing inflation. Developed markets, led by the US, outperformed emerging markets (EM), although both experienced declines in the fourth quarter. Treasuries were mostly weaker during the year with the curve steepening and faced a significant sell-off in Q4, with the policy-sensitive 2-year yield rising by 60 bp and the 10-year by nearly 80 bp. The US dollar strengthened by 7.0% in the year, after a 2.1% softening in 2023. The index was up 7.6% for the quarter, marking its largest quarterly gain since Q1 2015. Commodities remained flat for the quarter but ended the year with positive returns, largely due to gold’s performance.

Quarter in Review

At the start of the quarter, uncertainties centered around the US election and geopolitical tensions were front and center. As the quarter ended, the election result was known, and the potential impact of new policies, particularly in relation to tariffs, was moving to the forefront. The real assets strategy declined in the last quarter of the year, with mixed returns across months. In October the strategy lost 2%, in November it rose just under 1%, and in December fell again by 3%, making the quarterly return -4.25%, approximately 5 basis points better than the composite benchmark. However, for the the whole year the strategy did post a positive return of 4.5%. The longer-term returns remain solid and since its inception in 2005, the strategy continues to maintain its lead over the composite benchmark by over 22 basis points annually and has provided an annualized return of 4.2%.

Commodities (as measured by the Bloomberg Commodities Roll Select Index) experienced slight declines in Q4 as losses in both precious and industrial metals offset gains from the energy sector. Commodities fell 0.53% for the quarter, but rose 5.9% for the year. Natural Resources really lost ground in Q4, losing 10.8%, much of which can be attributed to diversified metals and mining. China’s economic slowdown has also caused a decline in demand across natural resources, especially considering the market share they usually boast. Natural Resources was the only asset class in the Strategy to end the year lower, returning -5.5% for 2024.

Real estate investment trusts (REITs), an interest rate sensitive asset class, declined for the quarter as yields rose; the Dow Jones US Select REIT Index fell 5.9%. The last quarter was tough for REITs across most property sectors, with self-storage declining the most, followed by industrial and specialty REITs. Data Centers stood out for its solid return of 8% in Q4. For the year, REITS rose 8.1%, much due to the strong third quarter. Infrastructure equities fell in December, also tied to rising interest rate expectations and some level of profit taking at year-end. Of the asset classes in the Strategy, Infrastructure performed the best for the year, adding 14.05%, despite losing 2.6% for the quarter. Lastly, TIPS outperformed comparator Treasuries in Q4 2024. The full TIPS Index (Barclays Series-B) returned -3.0% and the 1-10 year returned -1.6%, while comparator Treasury indices returned -3.2% and -2.1%, respectively. The 1-10 Year TIPS gained 3.3% for the year.

Investment Outlook

Energy markets entered 2025 with a lot of uncertainty and a bearish consensus forecast due to expectations of oversupply and lower demand. The bearish sentiment is likely overdone and the oil market should be more balanced in 2025 due to stronger-than-anticipated demand and strict supply controls by the Organization of the Petroleum Exporting Countries (OPEC). Potential headwinds include US President Donald Trump’s promise of reduced prices as well as the possibility of excess capacity brought on by Saudi Arabia. Nonetheless, demand remains strong, and OPEC+ is incentivized to maintain prices to balance budgets. Additionally, risks may be skewed to the upside in the near term, following recently announced Russian sanctions with the goal to stunt Russia’s energy sector and the possibility of Iran sanctions, among other geopolitical tensions.

Industrial metals entered 2025 with softer near-term expectations, but better intermediate prospects. Macro factors, such as policy and geopolitical issues, are expected to drive metals near term, but fundamentals are still solid and set metals up well when sentiment and demand improve. Robust US economic activity combined with the potential for further stimulus in China and further central bank monetary easing could support metals further into 2025.

The outlook for precious metals remains positive, but the next leg up could be more challenging. Expectations for Fed rate cuts have declined, and combined with numerous other factors, this has kept upward pressure on yields, including on real yields, which remain elevated. However, inflationary pressures, deficit concerns, central bank purchases, and de-dollarization could be beneficial for the yellow metal. Silver could benefit from a pickup in manufacturing activity and the ongoing energy transition.

Natural resource equities may face headwinds from slower growth outside of the US. But valuations are attractive at these levels and capex restraint has been beneficial, while the potential for deregulation in the US and possible tax cuts could help improve earnings further. Additional catalysts include further stimulus in China, uptick in inflation, and the potential recovery in manufacturing activity. Further, some integrated oil & gas companies will benefit from the secular AI thematic and the rise in data centers, which will require large amounts of energy.

Global infrastructure valuations continue to be well supported with price-to-earnings below the 10-year average, current price-to-cash flow just below the 10-year average, and current price-to-book ratio slightly higher yet still attractive. While infrastructure generally benefits from falling yields, rate sensitive infrastructure equities could face a challenge with the potential for a future rise in rates. However, a focus on onshoring production and pro-US growth policies in the US, including previously passed infrastructure bills, could provide a basis for positive returns. Furthermore, thematic tailwinds such as AI and increased progress towards energy transitions should continue to create demand and require investment for power generation, transmission and storage with utility and energy infrastructure companies leading the way.

Public REITs returns faced a negative quarter on the back of decreased confidence resulting from the hawkish tone of the Fed and uncertainty in future rate cuts. REITs have generally underperformed traditional equities over the last few years, and lower interest rates along with solid economic growth may pave the way for increased returns for REITs in the future. REITs may also benefit if concerns arise about tech valuations and if investors become more confident that rates will stabilize or fall. The data center sector should continue to benefit from AI demand and supply constraints, aiding in performance. While there is some upside potential for REITs in the longer term, in the near term, there is uncertainty regarding rate decreases. Rates could even move higher, which would continue to weigh on REITs’ performance.

Real yields are currently attractive, but the prospect of fewer Fed cuts will weigh on the performance of bonds. Inflation-linked bonds could also rally and perform positively given that upside risks to inflation remain, but breakeven rates have risen and now sit above long-term averages, which could limit upside potential for treasury inflation-protected securities (TIPS). While there is still potential for positive returns, it will not likely be a smooth path and TIPS are likely to remain volatile.

Inflation and Real Assets

If we think back to the onset of inflationary pressures in 2020 and 2021, demand was buoyed by government stimulus. The labor market tightened with wage growth rising well above pre-COVID levels, rent and used car prices spiking, and supply chains becoming stressed. Fast forward to today and some of those pressures have faded, including government stimulus payments, but others remain firm or have been rising recently.

Inflation has moderated from the peak in 2022 and stabilized above 2%, but our internal forecast remains for modest disinflation with core PCE receding to 2.4% year-over-year by the end of 2025, up from 2.1% three months ago. We still believe risks remain that could challenge the outlook and keep inflation higher than expected or pose upward pressures. This concern appears to be shared by investors with breakeven rates steadily rising since September, particular shorter-dated rates (Figure 4).

Pro-US growth policies, such as deregulation and tax cuts, could pose more demand driven upward pressure on inflation, especially with the labor market remaining solid. To that end, stress on households does not appear too onerous, with debt to disposable income still reasonable and savings remaining solid. Additionally, credit conditions are improving based on the Senior Loan Officer Survey where the percent of banks reporting tightening standards has been declining and the percent of banks increasing their wiliness to make installment loans continues to improve, both towards pre-COVID levels.

While there are pockets of softness in the labor market as a result of low hirings and a weaker labor diffusion index, the overall picture remains modestly positive. The three-month moving average payrolls reports, the constructive Job Openings and Labor Turnover Survey (JOLTS) report, and unemployment claims are still supportive. Elsewhere, small business sentiment has improved as the NFIB Small Business Optimism Index improved markedly and hiring plans picked up recently. Outside of consumption, government spending on US pro-growth policies should aid economic growth and sustain demand. Further, the output gap in the US is positive, which indicates that economic output is now exceeding its potential. This often happens when demand is strong and can lead to higher inflation because the economy may be overworking its resources.

In previous notes, we have highlighted the bottoming of goods deflation, rental prices stabilizing, and the turn higher in used car prices, and these pressures remain. After bottoming in August 2024, goods deflation has eased and continues to close on pre-COVID levels. For used cars, which tend to track the Manheim Used Vehicle Value Index with a one quarter lag, prices continue to rise as the Manheim Index advanced again in December and year-over-year change is now positive. This suggests there is further upside for the inflation prints. While tariff announcements at the inauguration were more ambiguous than expected, it stands that autos and other goods could be impacted should tariffs be enacted with higher costs passed to consumers. For rent, real-time measures like the Zillow Observed Rent Index have stabilized, but lagging impact from previous immigration could exert upward pressure.

There are also other signs of higher prices to come, which could offset disinflationary pressures elsewhere. Food prices, as measured by the FAO Food Price Index, have been rising since June 2023 and these appear to lead the CPI food component by about one year. The food price index has been rising for more than a year and half, but the CPI food component only just started to turn higher. Higher input costs, weather events, and firm demand have been pushing prices higher. Eggs are an example where a bird flu outbreak has produced a jump in egg prices and the US Department of Agriculture (USDA) recently raised its price forecasts. Beef prices are also higher and the USDA reduced its beef production forecasts due to the current restrictions on cattle imports from Mexico while also raising price forecasts.
With small business optimism spiking over the last few months to a five-year higher on more business-friendly policy, plans to raise prices have also moved higher.

Additionally, prices paid in the ISM Services PMI survey have been trending higher, with December being the 91st consecutive month the reading has been expansionary (Figure 6). Fifteen of the 18 industries reported an increase in prices paid for December with no industry reporting a decrease in price paid per the Institute For Supply Management. Lastly, the Producer Price Index, which measures the selling prices received by domestic producers, has been rising and could put upward pressure on consumer prices.

Real Assets Strategy

At State Street Global Advisors, we have a seasoned, diversified multi-asset strategy that combines exposure to a broad array of liquid real asset securities that are expected to perform during periods of rising or elevated inflation.

The asset allocation is strategic and utilizes indexed underlying funds. It is being used by a variety of clients as a core real asset holding or as a liquidity vehicle in conjunction with private real asset exposures. The strategy is meant to be a complement to traditional equity and bond assets, providing further diversification, attractive returns, and a meaningful source of income in the current environment.

Addendum – AI and Real Assets

Just as Nvidia, Alphabet, and other software firms profited from the current AI boom, others sectors stand to benefit from the AI tailwind moving forward. Data center operators, the companies that build them (and provide equipment such as heating and cooling systems for the equipment), companies that provide services to data centers, such as networking and other IT, and the energy companies helping to power everything will all play a critical role in advancing AI capabilities.

There are two ways to gain exposure to AI. First, private funds allow investors to diversify exposure across the value chain and find opportunities not available in public markets. However, these investments typically require significant amounts of money and long holding periods. Alternatively, investors can leverage public markets to invest in stocks and sectors that help drive the growth in AI capabilities.

We believe our Real Assets strategy offers investors a diversified way to gain exposure to AI adoption through liquid, public markets. Given the multi-asset, diversified approach to portfolio construction, we believe our Real Assets strategy is poised to benefit from the increasing demand for all things AI. REITs and the energy and utility companies within our global infrastructure and global natural resource equity funds should benefit from favorable trends.

Data centers have been the focus recently, and rightfully so – they will store, manage, and protect digital data and are an integral part of AI advancement. Increased demand for data centers should help drive top-line growth for these two REITs. There are two major data center REITs that operate in the US. Equinix Inc is a large digital infrastructure stock with over 250 data centers globally. Digital Realty is another large digital infrastructure company with over 300 data centers and clients that include AWS, Google Cloud, and Nvidia, among others.

Together, they comprise roughly 14% of our REIT fund, which is benchmarked to the Dow Jones US Select REIT Index. There are some pure-play ETFs as well, but their top-two holdings tend to be Equinix and Digital Realty with roughly 25%-30% exposure, which means there would be overlap in exposure with our current REIT fund. While our fund lacks exposure to some non-US data center REITs, Equinix and Digital Realty are two of the largest and our total data center exposure is in-line with other diversified REIT indices.

With the number of data centers projected to expand substantially, power consumption will also increase, especially with data center operators expected to operate reliably round the clock. Global infrastructure equities can take advantage of this growth by storing and transporting the energy needed to power data centers. Utilities and energy infrastructure companies should benefit from the massive investment needed to increase power supply and distribute to the data centers. Utility companies earn profits by increasing capex on projects and then recovering the cost plus a rate of return approved by regulators. Larger demand will lead to greater investment by utility companies which should propel the sector higher.

Midstream energy companies will also benefit, particularly those focused on natural gas, as renewable energy alone cannot fulfill demand growth from data centers. As an example, Kinder Morgan, Williams Companies, and Enbridge are focusing on increasing capacity to generate more power to help meet increased demand, particularly from data centers. Our global infrastructure fund is benchmarked to the S&P Global Infrastructure Index and could benefit with allocations of 20% and 40% to energy and utilities, respectively.

Outside of infrastructure, some integrated oil & gas companies in our global natural resource equity fund could benefit from the rise of data centers. Alternative energy sources such as wind and solar will continue to grow, but they have yet to establish reliability, so traditional sources such as coal, natural gas, and nuclear are likely to continue to play a role. Exxon and Chevron are two companies that are looking to take advantage of the rising demand and will start to focus on natural gas. Exxon has announced it will build a natural gas plant to power data centers, while Chevron confirmed it is working on deals to use natural gas and carbon capture to power data centers.

Overall, we believe that our Real Assets strategy provides a liquid, diversified exposure to sectors that should benefit from the ongoing structural tailwinds from AI. While the changing landscape provides compelling opportunities, there are also risks that emanate from a delay in data center boom or countries not building as many centers as projected due to energy capacity limitations. Meanwhile, we continue to evaluate for opportunities to enhance our strategy.