“Stocks take the escalator up, but the elevator down.” Old investing maxim
This is our last market commentary of 2024, and it may be the most important. The foundation of long-term investing success is understanding how markets behave in the long run. We share more tactical views as well, and they’re also important. In fact, in the second half of today’s commentary we look back at the recommendations we shared at the beginning of the year in our 2024 Outlook and how they turned out. (Our 2025 Outlook is coming out in just a couple of weeks!) But emotions can run high over shorter periods of time and that makes us all more vulnerable to poor decision making. Understanding the bigger picture helps tune out the noise, avoid some potential big mistakes, and stay on target to reach long-term goals.
So as we close out 2024 and launch into the new year, hear are seven things all investors should keep in mind in 2025.
Go Into the New Year Expecting a Double-Digit Decline in 2025
Remember August 2024? It might be hard to recall now, but global markets crashed on fears over the yen carry trade unwinding. We pushed back against the sell-off at the time, but still, knowing that Japan was having its worst day since the 1987 crash and US futures were down massively overnight made for a sleepless night for your dear authors on that first Sunday in early August.
In the end, the S&P 500 pulled back 8.5% from peak to trough, the largest drawdown of the year. Take note though that since 1980 the largest drawdown of the year has averaged 14.2%. If most investors went into each year expecting a double-digit correction as uncomfortable but perfectly normal, they probably wouldn’t get so worried when it happens. If it doesn’t happen at all in a year then all the better, but the odds of it happening the next year increase. In the end, 23 of the previous 44 years saw a double-digit correction, with 13 of those 23 years still finishing positive.
What Matters Is Time in the Market, Not Timing the Market
Time can be an investor’s best friend. Each year will have scary headlines and reasons to sell, but that doesn’t mean you should. In fact, the longer you are willing to hold, the most likely you’ll make money. On any random day the odds of stocks being higher is about a coin flip at 53%. A full week? 56.6%. A full month? 60.4%. A year? 71.2%. Five years? 80.8%. 10 years? 90.4%. And over 20 years stocks have never been lower.
Sure, no one wants to buy something and wait 20 years to feel really secure about gains, but imagine what the returns could be should you buy when stocks were in a correction or bear market? They get much, much better. There’s an old saying that it is all about time in the market, not timing the market, and this is something all investors need to remember.
Valuations Are a Poor Short-Term Timing Indicator
Do you like buying things when they are pricey? Of course not, and investors feel the same way. Here’s the catch though. There is virtually no proof that high (or low) valuations can predict what stocks might do the following year. Going out many years there can be some advantage, but don’t get sucked into avoiding the stock market because a talking head on TV tells you stocks are overvalued. We heard the same thing this time a year ago and stocks have added another 20%. If you want to lighten up on overvalued parts of the maket that is fine, but to blindly go to cash could be a very bad mistake.
I looked at forward S&P 500 price/earnings multiples and S&P 500 returns the following 12 months and found the correlation was about zero. Without getting too geeky here, the correlation tells you how much two variables tend to move together. When the correlation is near 0, there’s no statistical tendency to move together at all, and that’s basically where we are. Rather than making investing decisions based on valuations, you are better off investing in days that end in ‘y’ if you ask me.
Don’t Mix Politics and Investing
I can’t tell you how many investors I’ve met over the years that didn’t invest in the stock market because of who was in the White House. A lot of people didn’t like President Obama and stocks did great. A lot of people didn’t like President Trump and stocks did really well. A lot of people didn’t like President Biden and stocks started slowly, but soared the past two years. This is obviously a bigger deal in election years and mid-term years, but it is still important to remember every year. I’ll say it one final time, don’t mix your political beliefs with your investing views.
Ignore the Scary Headlines; All Years Have Them
A cousin to the lesson above is remembering that every single year will have scary headlines. I’m old enough to remember back in 2013 when everyone freaked out because the island of Cypress was having financial issues. I’m serious, it was a very big deal for about a week and had many investors on edge. Then you look back and the S&P 500 gained over 30% in 2013 and you wonder what in the world we were thinking!
Here’s a great chart that shares some of the worst headlines we’ve ever seen, yet over time stocks still gained.
Average Isn’t So Average When It Comes to Investing
Stocks gain about 9% on average, but a little known secret is that something near the average return rarely ever happens, in fact, much larger moves, both higher and lower, are quite common. Incredibly, going back to 1950 stocks had ‘about an average year,’ with a return between 8% and 10%, only four times, and the average return in an up year is 17.6%.
Another angle — after this year the S&P 500 will have gained more than 20% 22 times compared with an annual outright loss 21 times. In other words, the historical odds of a 20% gain are greater than a down year! Most investors aren’t prepared for this type of annual volatility, but it’ll help them if they indeed are.
Volatility Is the Toll We Pay to Invest
We will finish with probably one of the most important lessons for investors. While stocks have gone up quite a lot in the long run, it’s still perfectly normal for them to go down in the short run. As the quote at the beginning noted, the declines always seem to happen way quicker than the advances.
With thanks to our friends at Ned Davis Research, historically the average year sees more than seven 3% dips and more than three mild corrections of 5% of more a year. In fact, it is perfectly normal to see a 10% correction as well, as one happens on average once a year. Print this off and stick it to your desk, as investors could do themselves a big favor by remembering that each year will see volatility and it is the toll we pay to invest.
Revisiting 12 Predictions From Our 2024 Outlook: What We Got Right, and Wrong
As we get ready to release our 2025 Outlook, we thought now would be a good time to revisit the views we shared in our 2024 Outlook just under a year ago. If you’ve followed us over the last two years, you know that we’ve had some strong views during that time, much of it in sharp contrast to the consensus. Ultimately, we express our views by how we build portfolios, and it’s within that context that we evaluate what we got right and wrong. That’s also how we try to keep ourselves honest.
One knock some critics have on us is that we’re “permabulls,” Of course, if you had to be a perma-anything, a permabull would be the way to go (though it may sell fewer newsletter subscriptions). Bear markets are infrequent and don’t usually last very long. That’s because they tend to be caused by recessions. Since the end of World War II, eight of the 10 bear markets have coincided with recessions. That’s one reason why we spill a lot of ink (or keystrokes!) on discussing the economy, an area where our “prediction” for no recession in 2023 and 2024 was seen as quite bonkers at the time. It turned out to be the right call, but more importantly, we like to think we got it right for the right reasons. With that, here’s the verdict on 12 calls we made in our 2024 Outlook.
One: Upside from productivity growth means expansion will continue in 2024
Verdict: Correct
Real GDP growth will likely clock in between 2.5 – 3.0% in 2024, boosted by productivity growth that is running quite a bit higher than what we saw from 2005 – 2019.
Two: Our Proprietary LEI suggests expansion continues. Consumption will be strong amid real income growth.
Verdict: Correct
Our proprietary leading economic index (LEI) for the US never indicated a recession in 2023 or 2024. (We populate a similar measure for 30 countries, and wrap it up into 5 regions, and the world.) This was mostly on the back of consumption driven by strong income growth, and strong household balance sheets. Real income growth was also boosted by falling inflation and lower energy prices. Employee compensation rose 5.8% over the past year, while headline PCE inflation (personal consumption expenditures) was up 2.4%.
By the way, our US LEI remains in a fairly solid place as we move into 2025.
Three: Cyclical headwinds from fixed investment fading, especially amid easing rates.
Verdict: Mixed
We expected headwinds from the investment side of the economy to fade as interest rates eased in anticipation of Fed cuts, especially housing. We thought business sentiment would improve as rates pulled back and also expected continued growth in manufacturing construction and equipment spending on the back of fiscal programs like CHIPS and IRA. Housing was positive in Q1 but started to fade as mortgage rates stayed elevated. We didn’t get much of a boost in business sentiment (except post-election), but we did see manufacturing adding to GDP growth after the first quarter.
Four: Inflation continues to pull back
Verdict: Mostly Correct
Inflation measured by the Fed’s preferred metric, core PCE, was running at 3.2% year over year 12 months ago, and it’s at 2.8% now (core CPI pulled back from 4% to 3.3%). Strictly speaking, we were “right,” but in all honesty, we expected shelter disinflation to drive inflation even lower than its current pace (along with goods deflation, including vehicle prices). We’re taking away some points for that.
Five: Expect the Federal Reserve to cut interest rates 3-4 times in 2024
Verdict: Correct
We kind of nailed this. Technically, the Fed cut 3 times, but by a total of 1%-point. Note that markets were pricing in 6-7 rate cuts a year ago, and so calling for 3-4 cuts was not exactly “consensus”. We did expect inflation to pull back, allowing the Fed to cut, but we also expected economic growth to stay strong (thus avoiding recessionary cuts).
Six: Forward earnings continues to grow, along with profit margins
Verdict: Correct
Next 12-month earnings for the S&P 500 were at $242/share a year ago, and it’s currently around $272. Forward margins are also at record highs of around 13.5%.
Seven: Bull market should continue in 2024
Verdict: Correct
This was supported by all of what came above — a strong economy, rate cuts, and earnings growth — but also the fact that historically, election years do better. All of this ended up being right, and we positioned our portfolios close to maximum equity overweights across the year. Now we did expect low double-digit returns for the S&P 500 in 2024, but strong momentum over the first six months led us to up that to around 20% in our Mid-Year Outlook. We adapt! Yes, 2024 total returns are likely to be quite a bit higher than that, but we’re still giving ourselves full points for this.
Eight: Mid and small caps favored on the back of more favorable valuations and easing rates
Verdict: Wrong
This one hurts. An above-trend economy, easing rates, growing earnings, and more attractive valuations is what led us to make this call and overweight mid and small caps in our portfolios, although it was only a moderately sized bet. One thing people say when small caps underperform is that the Russell 2000 index has a lot of negative earners. However, we use the S&P indices, which screen for positive earnings, so that’s not an excuse. In fact, year to date (through 12/26/24), the Russell 2000 index is up almost 14% on a total return basis, versus 10.7% for the S&P 600.
Another argument here is that it’s all about the Magnificent Seven stocks. But this would be bit of lazy analysis in our view. What’s interesting is that in 8 of 11 sectors, the market cap-weighted sector index outperformed the equal-weighted sector portfolio — industrials and utilities were the exception (the returns were close), along with real estate. So, this wasn’t just about Technology, or tech-adjacent stocks. In almost every sector, returns favored the largest companies. This is something we’re thinking deeply about and will discuss in the future.
Nine: Financials and energy sectors favored
Verdict: Mixed
Financials ended up being the second-best performer amongst the sectors, but our energy call was off. Though full disclosure: we removed our energy overweight early in the year, and overweighted communication services and industrials (along with financials). We do reserve the right to change our minds.
Ten: Intermediate maturity bonds outperform short maturity as Fed cuts
Verdict: Wrong
We got this wrong, plain and simple. At the same time, we were heavily underweight fixed income, and Treasuries, in our portfolios. So, we weren’t too unhappy to maintain duration close to that of the Bloomberg Aggregate Bond Index, even though it would have literally paid better to be in cash (short maturity Treasuries). Having longer duration did help during the bout of volatility we had in August, when Treasuries rallied. Also, we diversified our diversifiers, with exposure to gold and managed futures throughout the year. That more than overcame any drag from holding onto longer maturity bonds. But I’m still going to rate this “call” as something we got wrong.
Eleven: Credit likely to outperform Treasuries, but we prefer equity risk
Verdict: Correct
We got this right, and it was based on a strong economy with no recession in sight. Here are year-to-date returns for bond indices as of 12/26/24:
- Bloomberg US Aggregate Bond Index: 1.1%
- Bloomberg US Treasury Index: 0.4%
- Bloomberg US Corporate Index: 2.2%
- Bloomberg US Corporate High Yield Index: 8.1%
However, what matters is not the just call itself but portfolio construction. From that perspective, credit’s strength versus Treasuries is irrelevant. We had better exposure to the driver of that credit component through equities. And that’s why I rate this is as correct.
Twelve: US over international equities, due to a stronger dollar amid stronger relative economic growth
Verdict: Correct
You may be saying “Duh! Of course, you should underweight International given the last decade of outperformance by US stocks.” But again, we’d rather be right for the right reasons. The US economy did outshine everyone else in 2024, as we expected (and gave us enough reason to overweight US stocks). But we also saw dollar strength (even prior to the election), which ended up being an additional headwind for international equities. The MSCI All-Cap World ex US index rose 13.1% in local currency terms (through 12/26/24) but was up just 5.5% in USD terms.
Here’s the final count:
- 7 Correct and 1 Mostly Correct
- 2 Mixed
- 2 Wrong
We obviously did get some calls wrong, but that’s also where portfolio construction matters, along with risk management, and we think portfolios were pretty well constructed for resilience where we were wrong.
Keep an eye out for our 2025 Outlook. We wish everyone many happy returns in the new year.
This newsletter was written and produced by CWM, LLC. Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. The views stated in this letter are not necessarily the opinion of any other named entity and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.
S&P 500 – A capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
The NASDAQ 100 Index is a stock index of the 100 largest companies by market capitalization traded on NASDAQ Stock Market. The NASDAQ 100 Index includes publicly-traded companies from most sectors in the global economy, the major exception being financial services.
A diversified portfolio does not assure a profit or protect against loss in a declining market.
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