At the end of 2024, investors had good reason to pop the confetti. Last year was the second consecutive year with S&P 500 gains of over 20%, the first time that has occurred since the late-1990s. The S&P 500 closed 2024, up 23% to an all-time high of 5,869.
The impressive performance begs the question: Is this momentum built on actual muscle or helium balloons? And while the party is certainly going strong, should investors be looking elsewhere for better future opportunities?
- Valuations: The forward P/E ratio on the S&P 500 hovers at 21.4x, well above the 30-year average of 16.9x and pushing 1.4 standard deviations over typical levels.
In regular-person-speak, the market is quite optimistic about the promise of artificial intelligence and market-friendly policies from the incoming administration.
- Market Concentration: The “Magnificent 7” (Apple, Alphabet, Nvidia, Microsoft, Amazon, Meta, Tesla) keep hogging the limelight, contributing 55% of 2024’s gains. Their enviable profit margins, at 23.5% versus 9.3% for the rest of the S&P 500, are proof that market darlings can do no wrong—until they do. The top 10 S&P 500 stocks currently represent a record-breaking 38.7% of the total market cap.
- Earnings Outlook: Analysts forecast even rosier profits for 2025. S&P 500 margins checked in at 12.8% for Q3 2024, well above historical norms.
We’d like to think of it as the market humming along to its favorite tune—albeit one pitched a few octaves higher than usual. In 2022, the Equity market fell because the Magnificent 7 margins started to fall because of shrinking profit margins. In 2023, the companies cut their workforces, improved profit margins, and mostly stayed disciplined with their expense management. Will they remain disciplined in the face of growing capital expenditures for Artificial Intelligence? We will need to watch this closely.
International Markets
Overseas, it’s the same music, different volume knob. While the US markets are belting out show tunes, international equities are more like your moody cousin who’s got loads of potential but keeps to the sidelines.
- Valuation Contrast: The MSCI All Country World ex-US index trades at a whopping 37.8% discount to the S&P 500 on a forward P/E basis—a historically wide gap. To put that in perspective, the 20-year average discount is a mere 17.8%. If you have ever been tempted to shop for bargains abroad, you’ll find an entire clearance rack waiting.
- Regional Performance: 2024 returns were a mixed bag:
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- Asian Equities: Overall, Asian markets were up +2.06% (USD terms), as a strengthening US dollar hurt Asian market returns, which performed well in local currency terms, with Japan up 15% and Australia up 7.5%. Japanese corporate governance reforms have turned the once-sleepy sector into a relatively bright spot.
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- European Equities: Overall, European Equities were up 2.22% as a strong dollar and persistent economic woes again hurt returns. Picture a soccer match that just can’t seem to find a winning goal.
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- Emerging Markets: Emerging market equities ended the year up a respectable +11.63%, proving resilient despite a slowdown in China. If you ever doubted EM’s scrappy nature, let these numbers be your reminder.
- Sector Disparities: Across the globe, technology and consumer discretionary showcase the most significant discount compared to their US peers. Value investors have started drooling, but it remains to be seen if global fundamentals will turn that drool into actual profits.
Fixed Income Markets
Ah, bonds—a once-forgotten stepchild now strutting back into the limelight. With real yields higher than anything we’ve seen in recent memory, fixed income is now starting to get a second look from the “cool kids” table in finance.
- Yield Curve: The 10-year Treasury yield is around 4.6%, and the Fed, while having paused its rate cuts, is still making not-so-subtle hints about easing. The dot plot calls for a gentle decline in rates with a long-run estimate of short rates falling to 3.0%.
- Credit Conditions: Credit spreads, or the difference in yield a corporate borrower pays to borrow compared to the US government, remain historically low. These low spreads are a sign that the market does not see strains in corporate credit quality or risk of a recession:
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- Investment Grade: 80 bps (19.7th percentile historically).
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- High Yield: 282 bps (21.9th percentile)
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- Defaults? Practically on a spa holiday, sitting “well below” historical averages.
- Credit Conditions: Credit spreads, or the difference in yield a corporate borrower pays to borrow compared to the US government, remain historically low. These low spreads are a sign that the market does not see strains in corporate credit quality or risk of a recession:
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- Investment Grade: 80 bps (19.7th percentile historically).
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- High Yield: 282 bps (21.9th percentile)
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- Defaults? Practically on a spa holiday, sitting “well below” historical averages.
Market Outlook & Investment Implications
In a nutshell, We have a poster-child bull market in the US, with extra sprinkles of valuation risk and a discount bonanza abroad. Meanwhile, the fixed-income markets show expected returns that could give the asset class its first real moment in years.
Top of Mind Risks:
- Valuation Hangover: US equities are priced for a party that may or may not go till dawn.
- Market Over-Reliance: With top heavyweights disproportionately driving returns, any big stumble could jolt sentiment.
- Earnings Surprises: Analysts are collectively whistling “Don’t Worry, Be Happy”; any sour note could cause a market shuffle.
- Geopolitical Wrinkles: Because the world loves a good plot twist, be it trade disputes or diplomatic entanglements.
- Shifts in Monetary Policy: The Fed might have an itchy trigger finger—whether on rate cuts or more policy maneuvering.
Portfolio Positioning:
- Rebalance: If US equities have ballooned into an unwieldy portion of your portfolio, trimming is wise.
- Bonds Are Back: Higher yields mean more substantial forward return potential. It’s a novel concept, but yes, bonds can be interesting again.
- International Opportunities: Even if global equities haven’t been the life of the party lately, their discount may offer a compelling entry point.
- Quality Focus: Late-cycle dynamics reward companies that can navigate choppy waters—i.e., strong balance sheets and stable cash flows.
- Dollar-Cost Average: Given lofty valuations, it’s prudent to dip toes gradually rather than cannonball in.
In times like these, diversification isn’t a luxury—it’s the main dish on a market buffet that could soon see more volatility. Don’t forget: the best time to prepare for unexpected storms is when the skies are still blue. And if there’s one thing we’ve learned about markets, it’s that sunny days are often followed by quick—and occasionally entertaining—thunderclaps.
Stay diversified, stay curious, and keep a bottle of confetti leftover from 2024 on standby. You never know when the next party (or pivot) might begin.