The Weight of the Evidence
TLA continuously researches and monitors economic and market trends on behalf of the families we serve.
What, Me Worry?
Some will remember, “What, Me Worry?” as the motto of Mad Magazine’s Alfred E. Newman character. It’s not hard to see why investors are currently so enthusiastic. Despite overall pessimism and angst since the pandemic, 2023 and 2024 have provided back-to-back years of earnings growth, falling inflation and well-above-average equity market returns. So-called “hard indicators,” such as manufacturing and industrial production, have been positive for 24 consecutive months, one of the longest streaks since the early 1970s. Disposable income is up 31% and consumer spending is up 35% since the beginning of the pandemic. The Fed, which has lowered rates twice this year, has largely accomplished its dual goals of easing inflation during a period of “full employment.” All this during what we previously referred to as the “Rodney Dangerfield Economy” because it got no respect.
The S&P 500 is up a spectacular 26% this year, following a 24% gain last year. This year alone, the U.S market gains have added $11.4 trillion in market capitalization, equivalent to the markets in all the 19 countries of the Eurozone, Australia, and Switzerland combined.
Investors seem practically euphoric. The Conference Board’s survey of investor confidence in U. S. stocks is the highest it’s been in 36 years. Individual investors seem to be universally bullish, shunning diversification for concentration. In fact, to some, diversification seems to no longer be viewed as a risk-reduction tool, but as actually a hindrance to performance.
U.S. households now have more of their financial assets in equities than at any time in history. Even professional asset managers appear to be very bullish. In a recent Yahoo Finance poll, 16 of 17 major Wall Street firms forecast that 2025 will be another good year for U. S. stocks.
Additionally, investors are expecting the new administration to lower tax rates and deregulate major industries, both generally considered pro-growth policies. They have even created a new extra-governmental committee to streamline government services.
The bottom line is that a favorable 2025 economy and further interest rate cuts are universally expected to create further tailwinds for U. S. markets to ride.
Curb Your Enthusiasm
What if all that expected good news is already baked-in to the markets? After all, the average trailing 12-month Price-to-Earnings (P/E) ratio of the top 10 S&P 500 stocks is an astounding 48. That means that investors are paying $48 for every dollar of earnings. The P/E ratio of the whole S&P 500 is 26.8 – higher than 93% of the time since 1990. Even the forward P/E sits at a lofty 22; well above its 30-year average.
To quote Sir John Templeton, “Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria.” We’ve certainly experienced the first two phases over the past couple of years. The question is how long the third phase will last before we enter the fourth phase.
The third phase is often when speculation becomes rampant. Indeed, many investors have confused speculation with investing. At TLA, we are careful not to confuse the two. We recognize that even the S&P 500, which has historically been considered a “broadly diversified” index now has significant concentration. In fact, the top ten stocks of the S&P 500 now account for an astonishing 39% of its market capitalization.
We’ve learned over the decades to be on the lookout for consensus and speculation. We see both today. We don’t intend to get caught up in either. Our defensive posture is to “lean against the wind” by “buffering” to limit downside risk without giving up all upside growth.
