By Jeremy Bryan, CFA®
2024 brought us another year of positive gains in the stock market. The S&P 500 has been the leader of the pack, returning greater than 20% in both 2023 and 2024 and exceeding the performance of other segments like US small-cap, international, and emerging market stocks. Bond performance has had two straight positive years after a difficult 2022, but returns have been muted as interest rates have remained elevated and volatile.
Current market sentiment seems to be a balance of optimism and fear among investors. Investor optimism seems to stem largely from current economic conditions and sentiment surrounding an incoming administration deemed to be more “business friendly.” As we enter 2025, the job market is healthy and oil and gas prices are equal to lower than at this point last year. Those two facts alone create more positive economic sentiment for the American consumer, who continues to spend and remains the lifeblood of the US economy. Second, the prevailing sentiment of the incoming administration is that tax cuts enacted during the first Trump presidency have a high likelihood to remain intact while corporate tax rates may be lowered.
Investor fears seem to centralize around the belief of market peaks, especially when years end near or at all-time highs. This is similar to fears in the beginning of 2024. When markets are at all-time highs, there is a feeling that we are at the summit of a mountain where the only direction forward is down. While this fear is completely understandable, it is a fact that stock markets have to surpass prior highs in order to achieve growth just like investors need to surpass prior highs in order to achieve greater wealth. Second, the amount of earnings generated from the companies in the S&P 500 is also at all-time highs but is expected to grow again in 2025. Lastly, there is historical precedent for positive market returns after two years of gains of 20% or higher, but this has to pair with the knowledge that we will likely experience some level of correction during the year.
The situation, as we often see it at Gradient Investments, lies between pure optimism and abject fear. If jobs are abundant while inflation lowers, that is a good backdrop for the US economy. If unemployment rises while price inflation rises again, that will be difficult. If corporations are still growing and taxes are lower, earnings trends will likely be higher and that is a good backdrop for continued stock market growth. If our economy begins to slow or contract into recession, lower taxes may not be able to offset lower earnings and stocks may suffer. Knowing what will happen in advance is difficult, and even getting all of the above correct does not perfectly predict what the market will do as a result. This is precisely why timing the market is such a difficult proposition.
So, given both fear and optimism, what are investors to do? At Gradient Investments, we suggest one thing: Bring an umbrella.
- Bringing an umbrella does not mean bad weather (or a bad market) is a certainty.
- Bringing an umbrella means you are prepared in case bad weather (bad market) occurs.
Investors can bring an umbrella by taking some profits from the recent gains and rebalancing assets to ensure risk aligns with the objectives in the investment plan. In times when stocks perform well, investors who have not rebalanced may now be exposed to a greater level of risk than before.
Further, bringing an umbrella incorporates assets that provide some protection against potential market declines. Bonds can be part of this solution, but as shown in 2022, they can fall as well and should not be considered the sole component of the protection plan.
On the other hand, bringing an umbrella does not mean staying inside the house until the potential for bad weather passes by. In this analogy, staying inside means selling all of your growth assets based on fear of future doom and gloom and waiting until things are “all clear.” This rarely works in markets. Again, investors are likely to experience a correction in 2025 (it happens every year), but investment plans have to incorporate some level of long-term growth to offset the effects of inflation. Adjusting and rebalancing is a prudent form of risk mitigation, but “getting all out” and “getting all back in” based on fear and prediction is likely to lead to frustration over prosperity.
A well-defined investment plan tailors risk to an investor’s particular circumstances and time horizon. It is revisited regularly to understand changing circumstances along with ensuring asset allocation remains consistent with the objectives and risk tolerance. Bringing an umbrella fits in very well with this philosophy.
Just like in the real world, bringing an umbrella may feel overly cautious when the sun is shining. However, if sun turns to clouds, you will feel more confident and able to move forward without getting soaked in the rain.
