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A Bad Day for the Fed
A few months ago Jay Powell claimed victory. Last Sept he said words to the effect of “the time has come to start easing rates”. He initially cut rates by 50 points – followed by two more cuts of 25 basis points. Markets were thrilled at the thought of more cheap money – pricing in as many as 6 or 7 rate cuts over the next 12 months. However, at the time I asked why the need to cut? The data simply didn’t support it. Jobs were fine. The economy was growing. Inflation was not yet at its desired level. Why cut? However, whilst the Fed was busy running a victory lap – the bond market was less convinced. The US 10-year yield went the other direction — and appears likely to retest 5.0% in the next few months. What does this do to valuations?
What Could Possibly Go Wrong?
It would not surprise me to see 2025 repeat the drawdowns we saw in 2022. And we could see 10-15% lower in the first half. For example, during Q4 2021 – I warned of excessive valuations (specifically in tech). That was timely. However, it’s different this time. 10-year yields are now above 4.70%. And should they continue their march towards 5.0% – valuations (and earnings) will be challenged. That said, Wall St. “experts” are assuming significant earnings growth for next year (evidenced by the average 6,600 2025 target at an expected 25x forward multiple). They’re adopting a “lottery ticket” mentality – where the majority of investors naively expect extraordinary returns with little regard for downside risks.
And The New Year Begins… Slowly
The trading year for 2025 is under way. Markets have worked their way through the so-called Santa Clause Rally. For those less familiar – this refers to a period of trading between the last five trading days of December and the first two trading days of January. This year Santa delivered a fat lump of coal. The market lost ground. So what does that mean for 2025? Absolutely nothing! Don’t read anything into it! What’s more important is Q4 earnings season… and how company’s perform.
2025 – Finding Quality at Reasonable Prices
The S&P 500 recorded a 23.3% gain for 2024. For the first time since 1998 – posted two consecutive years of gains above 20%. Not bad right? Well if we extend our time horizon to include 2022 – the market’s CAGR is just 7.2% (below its long-term average of ~8.0% exc dividends) Mmm. Not as good. And over 5 years – the S&P 500 CAGR is is 12.7%; and over 10 years its 12.4%. It’s important we measure results over a period of at least 5 years (preferably 10). 2-3 years is a very short amount of time… where all kinds of distortions will happen. But over time – these distortions are always corrected. My point? Things always mean revert… and one should never ‘cherry pick’ dates to fit a narrative.