MARKET UPDATE DECEMBER 2024

I originally wrote this update yesterday morning (Dec. 18th) before the significant price decline in the afternoon. I want to comment on yesterday's market reversal before we look at the longer term trends discussed below.

12/18/24 DECLINE

The stock market experienced a sharp decline yesterday afternoon that began right after Fed Chairman Powell announced that there would be fewer rate cuts next year. The Fed is going to be more cautious in their rate cuts going forward because they are concerned about inflation.

The market was expecting more aggressive rate cutting in 2025 so this was seen as a negative surprise. Bond prices fell as well as interest rates increased after the Fed announcement.

The other surprise yesterday afternoon was the political maneuvering that introduced a last minute risk of a government shutdown. The bipartisan agreement recently reached on a short-term spending bill is being revisited based on pressure from the new administration. It is not clear yet whether this is a real risk or just posturing.

TWO YEAR TREND

The stock market has marched steadily higher over the past two years since the bear market bottom in October of 2022.  It is easy to lose track of where we were back then and where we are today in comparison.  Let’s look at the relative change in the S&P 500, the Nasdaq and the Russell 2000 since October 2022. 

The chart below shows us how all three indices have steadily climbed over the last two years.  The measure I am using is the relationship of the current price to the previous all-time high reached before the bear market of 2022.

For example, in early October of 2022, the S&P 500 was down about 25% from its previous all-time high reached at the beginning of 2022.  In December of 2024 the S&P 500 is now 27% higher than it was at the beginning of 2022 representing a 3-year gain of 27%.  The S&P 500 has climbed about 68% off the bottom reached in 2022.

Interestingly, the Nasdaq is now also 27% higher than its peak at the end of 2021.  The small cap Russell 2000 index has taken three years to get back to its peak at the end of 2021.

If you have been aggressively invested in the stock market like our customers over the last two years you have experienced exceptional gains.  The 2-year increase is 57%.   The S&P 500 has steadily gained about 30% in the last year. 

This level of increase in the stock market is quite rare historically.  Most measures of market valuations indicate that the stock market is overvalued at present due to the large gains in the last couple of years.  My valuation model suggests that the S&P 500 is overvalued by about 19% currently.  In the last 50 years, the S&P 500 has only had higher valuations one time – in 1999 at the end of the dot-com bubble and before the dot-com crash in the early 2000s.

As I have mentioned previously, valuation is not a good predictor of short-term market direction.  It is a good predictor of long-term market prices.  Unless AI delivers increases in corporate profitability of 20%, the market will need to correct at some point. The stock market is currently betting that AI will deliver large increases in corporate profits.  Time will tell.

In the near term, the stock market is keeping a watchful eye on economic growth and inflation.  The market currently is assuming that inflation is stuck at current levels and that interest rates are stuck as well.  The consensus is that the Fed will lower interest rates at a slower pace as they are concerned more about inflation than economic growth at present. 

Bond prices were expected to rise as interest rates declined but bond prices (inversely related to interest rates) remain stuck at levels that are 20% to 30% below what they were three years ago. 

The US continues to outperform all other global economies.  GDP growth is stronger in the US and productivity growth is much stronger in the US.

Despite the positive trend in stock prices, we do expect more volatility going forward.

There is a great deal of uncertainty around the economic policies of the new administration, particularly with regard to inflation.

When markets are overvalued, any negative news can cause a steep drop in the markets.  If you do not have a strategy to protect your money against losses like our Market Signals system, you need to be prepared to deal with higher levels of volatility in the coming years.

Stay Disciplined My Friends,

Phil McAvoy

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