January 2025 - Touch of Grey
The shoe is on the hand, it fits
There's really nothing much to it
Whistle through your teeth and spit
'Cause it's alright
Oh, well, a touch of grey
Kind of suits you anyway
That was all I had to say, it's alright
I will get by, I will get by,
I will get by, I will survive
– Grateful Dead 1986
Amidst another up and down year in the market, I became moved by the outpouring of support for legendary basketball player and Dead-head, Bill Walton, following his death. Arguably the second greatest college player in history, there was very little spotlight on his basketball career. Instead, there was this beautiful testimony from his family, friends and his basketball brethren on how wonderful he made them feel. In a year where we sadly lost six more clients, it is an inspiring reminder of what we remember when someone passes away. It’s not the money, fame or awards; it’s how you make people feel when you’re around them. What a legacy to consider as we ride through this long strange “road trip” called life.
I’m not a Dead-head like Mr. Walton, but I’m reminded that as we age, we become more grateful, and our thinking should become broader, not black and white. This update focuses on staying in the middle and tempering expectations, while uncovering new opportunities amidst the music. Numbers, although they seem black and white, can be skewed. The financial world can often be very grey.
2024
Last year provided another great year of +20% returns in the overall stock market and 17% for the average stock fund. (Source 1: Morningstar). The Magnificent Seven — Alphabet, Amazon, Apple, Meta Platforms, Microsoft, Nvidia and Tesla — accounted for more than 53% of the stock index’s total return, including dividends (Source 2: Morningstar). Nvidia alone made up 21% of the return, as the maker of artificial-intelligence chips saw its market value leap past $3 trillion.
Over the last few months I’ve uttered to many, “Thank you Mrs. Market. We’ll happily take these returns.”
This leaves us more focused on preservation of capital today, much like 2021, with the market at these lofty levels. A closer look at 2024 saw modest earnings growth, in the U.S., in particular, relative to stocks’ performance. The gains were mostly from expansion of the price-to-earnings multiple which would be difficult to repeat. The challenge is that growth continues to be below trend in many parts of the world, and high-quality assets are expensive, everywhere.
As Jeremy Grantham (head of GMO and a pessimist at heart) observed earlier this year, “We have totally full employment, totally wonderful profit margins. All the things you would not want to start a bull market from. This is from where you start bear markets from. Great bull markets start with exactly the opposite.” (Source 3: GMO March 2024) In 2023, my newsletter mentioned there were pockets in the portfolio to be somewhat excited about. Today the financial numbers paint a different picture with an overall market that is expensive. While many want to rejoice at Artificial Intelligence, which has been a nice tailwind, investors should temper expectations moving forward with valuations stretched.
2025 — Fire, Fire on the mountain.
It is highly unlikely the market will deliver 14% annualized returns over the next 7-10 years as inferred by some random investors recently. Historically, today’s current market levels should NOT give you a warm and fuzzy feeling. People want more of the same, but the projected 10-year returns on S&P is +2/-2% ANNUALLY according to the Schiller PE (Warren Buffett’s favorite indicator). Warren (ever the optimist unlike Mr. Grantham above) is highly skewed to cash right now (probably not a coincidence).
Lastly, we have David Giroux (all-star manager of TRP Capital Appreciation. I’ll call him a realist.) who estimated his 5-year number on the S&P is the lowest potential rate of return that he has ever calculated going back to 2000. In his world, risk-return on bonds looks more attractive in some instances vs stocks as he has reallocated 8% of his fund toward income vs growth (Source 4: Barrons Roundtable Jan 2025).
Conclusion: Three very trustworthy sources (Buffett, Giroux, Grantham) from three different colors of the spectrum — all seem very concerned. We will stay cautiously optimistic, but this has my full attention.
Source 5: BlackRock and J.P. Morgan forecasts as of September 2024. Schwab as of October 2024. Vanguard as of November 2024. Morningstar Multi-Asset Research and Research Affiliates as of December 2024.
Interest-Rates, Trump and the Fed: “Truckin’…Got my chips (already) cashed in.”
Central bankers have made clear that with price pressures remaining sticky, they are in no hurry to cut interest rates too quickly or deeply. The Fed cut interest rates at its November and December meetings but shocked markets in December with a major change to its projections for 2025, rattling markets. The Fed’s most recent projections suggest just two more 0.25% cuts in 2025, down from four, in its projections from the third quarter.
My personal opinion is that the Federal Reserve won’t cut rates because they have to, but because they want to (unless there is a recession). Similar to Q4 in 2018 going into 2019, when they wanted to have their cake and eat it too. Entering 2019, Wall Street expected two rate hikes. Instead, the Fed cut rates three times in the face of trade uncertainties, weaker global growth, and tepid inflationary pressures. The hell with the future, I want it easy-peasy, and I want it now.
Entering Trump’s second term, will we see a repeat performance of this easy policy? The projected budget deficit of $1.9 trillion is already likely to reach more than 6% of economic output, a threshold crossed previously only during World War II, the 2008-09 financial crisis and the Covid-19 pandemic. With proposed tax cuts (or an extension)—and soaring Social Security and Medicare costs — projected to keep annual deficits at a historically high level, the debate over deficits continues (Source 6: WSJ Jan 2025).
I had a discussion with client a few months ago about the debt who asked, “so when will this become a problem?” My answer was “I thought it already would be a problem. But it becomes a problem when it becomes a problem.” When you think logically, does the person who is overweight, out of shape and drinks too much, have a problem when they have a heart aack, or did they have a problem during years
of turning a blind eye?
Time will tell and Trump may measure his success more so on the success of the market, not whether the average American can afford groceries. He likely will do anything to prop up the economy. Trumponomics’ priority of tax cuts, tariffs and deregulation might be supportive of economic growth short-term. But it could lead to a stronger dollar, inflation and increased interest rates, which would be negative, longer term. We must also consider that cutting interest rates PRIOR to a recession has been highly negative for stocks over the full cycle. Note that the Harris/Biden agenda was economically flawed as well, with a “spend first” mentality. The grim, grey reality is that both sides are guilty of increasing the debt over the past 20 years. See below.
Bonds and Small Caps – Opportunity – “Roll away… the Dew”
For several years, we guarded against interest rate risk as it relates to the bond market when rates were at historic lows. Although bonds remain an important component of a well-diversified portfolio, from a historical perspective many of our portfolios contained bond allocation that was below average. This helped in 2022, when the bond market lost 13% due to inflationary pressure and rising rates. Today, addttonal bond allocation may now finally help provide higher income to investors, diversification and a potentially supportive economic landscape. If interest rates actually do decrease, this could be a positive for bonds since they are inversely correlated. Conversely, if rates stay flat, this wouldn’t be a bad thing.
I’ll reiterate, in December, the Fed squashed expectations of a prolonged rate-cuttng cycle. Central banks have been able to aggressively raise rates (for 18 months until Sept of last year) without harming the economy, then slowly cutting them, while launching hawkish messages. This action of significantly raising rates, with no major adverse effect on the market, is unprecedented. Therefore, if the stock market pulls back dramatically, bonds offer a buffer and historically have provided a cushion and diversifier to stocks during a hard fall. On the other hand, the Federal Reserve will also have room to cut rates IF an actual recession occurs.
We are looking closer at the small-cap stock sector which has been out of favor versus the broader market for 10+ years. The Russell 2000 (small-cap benchmark) is 8.7% off its record close from November 2021, while the S&P 500 has risen 25% over that time. (Source 7: Morningstar 2025) The disparity of 33.7% has money managers thinking the market’s smaller stocks may be due for another look. We are selectively planting seeds carefully on a case-by-case basis, although this sector is more susceptible to a pullback if a recession hits.
Conclusion
What should one do from an investment perspective? While we can’t predict, we are prepared with multiple strategies in place depending on the client:
- Clients strategically have many years of needed income invested AWAY from the stock market. This may be allocated to safe, high-yielding cash, short/mid-term bonds, etc., so they are able to handle volatility and a downturn, if and when one occurs.
- Clients may have a fixed product or notes that limit the upside potential but fully seeks to protect on the downside.
- Clients may have a partially safeguarded downside investment.
- There is a small portion of portfolios that may be hedged or invested in gold and gold-related securities.
- In our core equity positions, we seek to protect first and seek to grow second.
We get stuck over the years believing the same front-page news in the form of our phone these days. The more we listen to one media outlet, the worse that bias becomes. One wants you to believe one narrative and the other outlet is an about face. The reality is that the world is grey and the truth is somewhere in between. The expectation is that the market will continue to climb, and that Trump and Co. will be able to wield a magic wand over the economy, which may be a bit of a stretch. The reality is that both sides ignored economics when making campaign promises that lack understanding of much larger problems that have existed for some time. Unlike campaigns, where anything can be said, there are no freebies in free markets and life.
We will stay optimistic but grounded in our approach at this time.
Stay warm and stay positive.
Source 1: Morningstar 2025
Source 2: Morningstar 2025
Source 3: GMO March 2024
Source 4: Barrons Roundtable Jan 2025
Source 5: Morning Star. BlackRock and J.P. Morgan forecasts as of September 2024. Schwab as of October 2024. Vanguard as of November 2024.
Morningstar Multi-Asset Research and Research Affiliates as of December 2024.
Source 6: WSJ Jan 2025
Source 7: Morningstar 2025
The Standard & Poor’s 500 Index is 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 Dow Jones Industrial Average is comprised of 30 stocks that are major factors in their industries and widely held by individuals and institutional investors.
The opinions voiced in this material are for general information only and are 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.
Investment involves risk including loss of principal. No strategy assures success or protects against loss.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
Asset allocation does not ensure a profit or protect against loss.
Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.
The prices of small cap stocks are generally more volatile than large cap stocks.
The Russell 2000 Index is an unmanaged index generally representative of the 2,000 smallest companies in the Russell 3000 index, which represents approximately 10% of the total market capitalization of the Russell 3000 Index.
The fast price swings in commodities will result in significant volatility in an investor’s holdings. Commodities include increased risks, such as political, economic, and currency instability, and may not be suitable for all investors.