Please find an excerpt from our December 2024 Newsletter below.

The US Economy, the US Stock Market, and the Future

Despite the recent bout of inflation and sharp interest rate increases, the dynamic US economy has not come close to recession. This strength has been fueled by many well-known factors that have been positive attributes in the US for a long time. Though some of the fuel has come from not so positive aspects, such as record debts and deficits. There will be a lot of factors from technology to government policies to company management that will determine how long this cycle will continue; with the hope we are not headed to another debt crisis. The policies being contemplated in the US, such as stable or slightly lower taxes, decreasing regulation, a big cut in government spending, would all, if managed well, certainly keep this party going.

“Plans are successful only to the extent that they can be executed.”
- John C. Maxwell

While there has been a lot of talk about stock market optimism since the Trump election, the truth is the US markets are only up about 2% since September 30 (well before the November 5th election results were clear) and are up about 23% for the year; the Trump stock market bump has disappeared. Certain investments like cryptocurrencies, Nvidia and Tesla’s share prices are up a lot more. For the US markets and economy to keep expanding at even close to the rate of the last several years, a lot of things are going to have to go right, including a big jump in corporate profits. When I start to see articles like this “Should investors just give up on stocks outside America?" I start to get a little more cautious, diversification still has value. So, what then to think about next year as investors? 

“Prediction is very difficult, especially about the future” is a tongue-in-cheek quote often attributed to Niels Bohr (and others), the famous Danish physicist. The wisdom behind this saying is often forgotten as the rewards for predicting the future correctly can be high; and the media loves to show how “smart” these people with any particular “correct” predictions are; though much of “being correct” is down to luck even if the reasoning behind the guess was sound.  Without a proverbial crystal ball, while we may not be able to predict the future, a good understanding of statistics, with enough similar data, can often give us some clues of not what WILL happen, but the likely range of events.

When being asked, “What do I think will happen in the US stock market next year?”, most people would like to hear an answer something like, "The US stock market will likely be up 10% next year". This is easy to understand and happens to be close to long-term averages. However, if I said that “I have a 95% confidence that the US stock market will have returns of between -10% to positive 20% next year and this will be normally distributed around a 10% return as the most likely outcome”, I would sound like a math nerd and most people would shutter with the memories of math classes they did not enjoy. I happened to have had a great statistics professor, Tim Kelly, many decades ago, one of my favorite classes. The reality though it is not so much what I think matters is what we should do based on any individual client’s overall situation.

Predicting what will happen to the price of anything in the future gets more challenging the further into the future we try and predict, but in the real world we are stuck making choices with imperfect information all the time. In fact, we all do this every day, we don’t know if there will be a road closed or a train running late on our way to the office in the morning, or if the internet service will be down or if it will rain…yet when the unexpected happens, we adapt. That is all about risk management.

When looking at the future of a particular stock market, we, as investors, are trying to gauge some important measurable variables such as the profits of companies and interest rates, and then we are trying to predict things such as future profitability, its growth rate, taxes, and sentiment to name a few major inputs.

The S&P 500, largely known as “The US Stock Market” has had from 2019-2024 annual returns of 29%, 16%, 27%, -19% 24%, and ~26%, an average of a 17% increase per year. The long-term average since the 1950s is a little over 10% annually, 17% a year returns seem unsustainable; though it also seemed unsustainable in 2022 when many people were waiting for an even bigger correction.  A question I have periodically posed in this newsletter and often in meetings, is “Are you ready for a 20% or higher drop in the value of your investment accounts because of a drop in the stock market of 25% or more?” In fact, we should always be ready and prepared for such a drop, and we should expect most of the time, for US markets to recover to a new all-time high within two years, though it can and has taken much longer a couple of times in the past 80+ years. 

The reason that posing these questions about the future is important is that it helps us focus on risk management for an individual’s situation and assessing how much risk we are comfortable advising to take. Looking at past times of extreme stress in the world and the financial markets is a good, but imperfect guide to the future, adding in an individual’s likely cash flow needs is equally important factor.

Ultimately stock market valuations are driven primarily by the financial strength of the companies that are listed and this in comparison to other investment choices and the Federal Funds rate. On this score, many companies listed in the United States are strong and getting stronger; though their valuations are looking stretched when compared to past norms. Sentiment is another factor that can drive markets to over or undershoot their intrinsic values. These effects can happen in very short time frames or much longer ones. Market places of all sorts are a place where information gathers, en masse, and one of the outputs major outputs in a market is the price of any given component. Today there is a mix of optimism (a lot of people got the results they voted for) and pessimism as a lot of people are very concerned, even the ones who got the vote they wanted.  Market valuations are close to an all-time high in aggregate, driven by strong underlying profitability, and this, in spite of relatively high US interest rates.

We are seeing articles such as “The Mother of All Bubbles”  and “How the Mother of All Bubbles Will Pop”, where a journalist is writing an opinion piece on why it makes sense to bet against the United States stock market. Undoubtedly, there are some elements of truth in there, but the danger of trying to take these pieces and applying them to decision making is the same reason that market timing does not work. For all the froth in the market in the US, the economy there certainly seems to have the best prospects now for future expansion.

One thing I have often stated is that it is very hard (even or especially for professionals) to predict even short-term moves in the stock market. When advising our clients, we look to their individual situations, not just financial, but also, if they are extremely stressed and losing sleep over their concerns. If clients have stable employment and enough cash and short-term bonds to weather several years of waiting for the stock market to recover from a big fall, these are also important factors. So, if you have any upcoming large cash needs on the horizon in the next couple of years, then it is better to not put this at risk in the markets.  If you are regularly losing sleep due to anxiety about geopolitical concerns, then perhaps we should schedule a time to talk.  There is a lot going on in the world to create uncertainty, though this is almost always the case, it is just highlighted in different ways through media, social contact/networks, etc. Times like now tend to make us more aware of the uncertainty that is always with us.

We know that historically, a 10% drop in the US stock market happens about once a year (it has been quite a while since this has happened) and a 20% or greater drop happens about every 3 years or so. During most periods, a recovery to a new high mark rarely takes more than 2 years,

at least in the US markets (around 60% of the total world’s public equity markets today) this has been the case. Knowing what to sell, when to sell it then what to buy, it takes 4 right decisions in a row, consistently to make market timing work. This is why it rarely beats, over long periods time, the “buy, hold and rebalance approach” that we use.

During the current period, there are several things that could cause economic growth to expand, and if it does not, the Federal Reserve could aggressively cut interest rates to spur growth to pick up again. There are a lot of geopolitical, and political, challenges, and I would argue that Europe and China especially face some much bigger challenges economically, demographically, and politically compared to the US, where large businesses tend to do well whomever is in control in Washington. While there will be a lot of individual impacts stemming from the election, most probably for illegal immigrants, federal workers, some targets of retribution, and more, there will also likely be a benign tax and regulatory environment and some of the changes could indeed be positive. The US is a big, dynamic, and a complex place that no one person or party can easily control for too long. Like so many other periods of political uncertainty, we are not advising making any global changes but focusing on each individual client’s circumstances.

Our clients find our newsletters to be a valuable part of working with White Lighthouse.
A sample of our past newsletters is freely available below.