Hi all,
As you know, we’ve been cautious the last several months (especially on large cap companies) as the equity market valuations have kept us from committing some capital with relative confidence. Hearkening back to November’s post, we wrote:
“This is not to say that the economy or the stock market is going to crash, but trees don’t grow to the sky. It’s often the car you don’t see that causes the accident, and we continue to believe that caution in adding additional capital to equities (large cap equities specifically) at nosebleed valuations is warranted.”
We now know the “cars”: Last week it was Deepseek, this week it’s tariffs.
One unsubstantiated media report led to the largest one day decline in terms of market cap ever in US history (Nvidia lost roughly $600B on Monday). I am not an artificial intelligence expert, nor do I play one on TV, but the short story is that an AI firm out of China has claimed to duplicate the computational prowess of some of the fastest growing and largest US technology firms for a tiny fraction of the cost.
I have no idea if this is true. You have no idea if this is true. But the takeaway from this week’s decline in the stock market SHOULD be that when you build in positive assumption on top of positive assumption, you leave yourself open to a small negative possibility causing an out sized amount of pain to your portfolio. It’s just a poor risk/reward trade.
If you are someone who wants to parse through how this potential cost-cutting technology could be revolutionary for how much spending the large technology firms won’t have to make in the future, or who the winners and losers could be in a global trade war, go ahead. It’s a fool’s errand. Think more about what this DOESN’T change. The future needs for cybersecurity. The potential applications for the future of individualized healthcare. The ability for firms who couldn’t commit the amount of money needed to play in cutting edge technologies, now being able to implement cost savings measures in their own businesses.
Now let’s look at a few charts (my favorite) to see where we are to start 2025.
- The NYSE Advance-Decline Line Divergence
The S&P 500 made a new all-time high in price on January 22nd, but the numbers of stocks inside the S&P 500 has not confirmed that high in price. We had a similar divergence in November of last year that rectified itself by the advance-decline line making a new high late in the month, so that’s not to say that all divergences lead to declines, but most declines start with these types of divergences. Something to keep a very close eye on.
2. Some rationality in valuation is a positive for this market.
Last year’s winners have started 2025 by coming back to the pack a bit. The only sector down this year (I know it’s early) is technology. This broadening out of the stock market is generally a net positive (unless you’re overextended in technology and semiconductors). We see this broadening as an opportunity to continue to build positions in client portfolios in the unloved sectors from the last several years (healthcare, real estate, energy), and we will likely overweight small or mid-caps over large and value over growth.
3. Post-Election Years
While pre-election years have been the best performers over the past 75 years, a new trend has emerged in the last 40 years, with post-election years being the largest gainers. Over the past 10 cycles, 9 out of 10 have been higher, with an average gain of 18.1% per year. Since the market has a bullish bias anyway (stocks DO go up over time), you can always torture the data into saying what you want, but it’s certainly on the positive side of the ledger for 2025.
The net effect of all of this is that fear and uncertainty have entered the stock market in a big way to start 2025. Most see this as a negative, but a broadening out of the bull market should simply be seen as new leaders taking the baton. Don’t make the mistake of thinking yesterday’s winners will be tomorrow’s darlings, too.
– Adam