Posted on Dec 3, 2024 by Jeremy Bryan, CFA®
As we enter the final month of 2024, stocks in the S&P 500 are near record highs. As you may recall, stocks ended 2023 near their all-time record highs as well. As we exit 2024, we have climbed more than 20% above the record at that time.
Any time markets are near record highs, there is justifiable concern that the summit has been reached and we can only decline from here. Market history has proven, however, that all-time highs are not necessarily warning signs of pending doom. In our opinion, markets that experience positive momentum, like we have now, often continue far beyond investor expectations.
As we look forward, first consider that December has historically been one of the strongest months of the year for stocks. Second, economic trends have remained relatively resilient and consumers, based on Black Friday spending data, seem to be continuing to spend even as they change how and where they spend. Lastly, the US Federal Reserve decision on the Fed Funds rate will come with the possibility for another 25-basis point (0.25%) cut.
With many tailwinds in our favor, the negative case on stocks seems to center around valuation. We are paying more for stock earnings now than any time since 2021 and are at exceedingly high levels compared to long-term history. Bearish investors are pointing to similar valuation levels in 2021 and the negative performance of 2022 and correlating the current situation in 2024 to a potential outcome for 2025.
At Gradient Investments, we do not dispute that markets are expensive compared to history. We do not, however, see a perfect correlation between markets in 2021 and now. The biggest difference is the expectations of Federal Reserve policy and rates. In 2022, inflation was above 7% and the Federal Reserve was set to embark on the fastest increases of the Fed Funds rate in history. In 2024, inflation is much closer to long-term averages while expectations are for the Federal Reserve to stabilize or decrease rates. That is a vastly different scenario and has been a historical tailwind for stock prices.
Second, valuations are important for long-term return expectations but are not great timing signals for markets in the next six to12 months. When markets are expensive, like they are now, investors should expect more modest returns compared to long-term averages. When markets are cheap, investors could rely on better-than-expected returns over long-term averages. In the near-term, however, expensive markets can get more expensive just as cheap markets can get cheaper. Trying to time markets based on valuation is a difficult proposition, but investors should temper expectations about future performance compared to recent history.
Now, this is not to say the market is not without challenges that could create a change in momentum and possibly a bear market (a decline of 20% or more). Geopolitical risks continue to be elevated and volatile. In the US, the new administration will begin implementing policies and enacting their agenda that could change the course of economic growth. Further, businesses will begin reporting results and their yearly outlooks in January which will likely influence the expected growth rate of earnings in 2025.
All of these are somewhat known risks, even if we do not know the extent of the risk yet. Usually, what has the greatest impact on market performance are the unknown risks or what we cannot see coming. Recent recessions and bear markets have largely been the byproduct of surprise economic events, such as:
- The dot.com bubble burst coinciding with 9/11.
- The housing crisis boiling over into near collapse of the financial system.
- COVID forcing changes to daily life and nearly shutting down the economy.
- The recent bout of inflation, which did not cause a true recession, but many of the effects and market declines made it feel like one.
In our opinion, these events can happen any time and are the predominant reason for Gradient Investments “Protect and Participate” philosophy. Protection should always be a part of any investment plan as it provides a margin of safety that allows investors to stay the course during times of stress. Participating in market upside, however, should also be a part of all strategies as it allows investors to grow in excess of inflation and increase wealth over time. The customization of any well-designed investment plan focuses on providing both in a way that fits the client objectives but stays within the bounds of their risk tolerance.
