Market Volatility Should Not Be a Surprise...
December 21, 2024
The Federal Reserve upset the market on Wednesday. They cut rates by a quarter of a point and then signaled that additional future cuts in 2025 would likely be more limited than previously indicated. Everyone was discussing and expecting a ‘hawkish’ cut, meaning that there would be the expected rate cut and then the Fed would speak more aggressively about future cuts which is exactly what they did. The only truly surprising aspect of this was that the market and investors were surprised at all.
The market was frothy and overvalued, and still is. Optimism was, and even continues to be, widespread and excessive. Consider Broadcom, a very successful technology company involved with AI, semiconductors, cybersecurity, and other parts of technology. An excellent investment in 2024, its share price had already risen over 60%. A week ago it reported earnings and gave guidance in line with expectations. During the follow-up earnings conference call, the CEO spoke very optimistically about the company’s future prospects,...and the share price rose another 38% - in two days. The company, already valued in excess of $700 billion, added over $400 billion in market value! A bit overdone, no? No…a lot overdone. Way too much froth, speculation, FOMO, performance chasing.
The Fed moment was just the excuse the market used for a long-anticipated correction, a deflation of the bubble. The decline was necessary, long overdue, and healthy for the market inthe long run. Long overdue? Yes. The recent rationales for ever higher prices were too easily given, accepted, and unconsidered. There was the exspectation of multiple rates cuts coming. Really? Why? The economy is still growing with only a few sectors (e.g. housing) having any issues overcoming ‘restrictive’ higher rates. Sure, inflation has declined significantly from its peak though it has stubbornly seemed to stabilize above the Fed’s 2% target. It is not clear that the economy needs much lower rates nor is it a given that it will get them.
How about the ‘coming’ tax cuts, another widely noted rationale. The tax cuts enacted in the previous Trump administration don’t even expire until the end of 2025 and, given the increasing concern about the federal deficit, how much more could they even be cut? Also generating market exuberance is the incoming administration’s intent to cut government 'onerous' regulation. Still, nothing has happened yet, it is not clear what will happen, nor how long until there is an impact. And it would not be unfair to think that some actions may have unexpected and/or unintended negative impacts. Again, not a great basis for additional gains on top of already elevated equity valuations.
Finally, it was offered that Donald Trump measures his performance by the stock markets so he will only do things to make the markets rise. That’s your downside protection? If it were so easy, the S&P might already be at 10,000 by now.
What is interesting is how myopic these visions were. Excitement about the expected pro-business stance of the incoming administration was overdone. How about the impact of the promised tariff increases? Not unreasonable to speculate that additional tariffs would raise prices, push inflation up, forcing the Fed to keep rates higher and more restrictive. And what about the aggressive plans for deporting illegal, and maybe even legal, immigrants? Does anybody think that will be helpful to business and the economy? Does anyone even know how that will roll out and what the impact will be? Just like it was said here about speculating on the outcome of the election, investing aggressively in the face of so much uncertainty is not a recipe for increased wealth.
And I have not even mentioned the widespread current geopolitical unrest. Yet money continued to pour into stocks as if everything was known, the world is a happy place, and all policy changes would be helpful. You can smirk and think how easy it is for me to deconstruct the market action with hindsight, but it was all there and hardly hidden before. And for some time now I have been suggesting everyone do a little trimming, cautioning not to be greedy. The equity markets could have a third straight year of gains in 2025 but it will not be a smooth ride...be patient and opportunistic. There will be good entry points along the way.
This will be the last time we are together in this space this year…and I want to leave you on a positive note. Despite the concerns expressed above, it is important to remember that even after Wednesday’s implosion, the equity market is still on track for a second successive year of solid double-digit gains. In 2025, AI will create productivity gains and profit margin expansion. There will be increased M&A activity and likely a loosening of the IPO market. The US equity markets remain the most attractive worldwide. There will surely be gains to be had alongside increased volatility in the coming months. Long term investors will be well advised to stay invested, patient and calm. And to remember that you are almost certainly much better off than you were, or even expected to be, at the start of this year. So enjoy it.
On a personal note, I wanted to tell you how much I appreciate all your feedback, positive or otherwise. I am just happy to be read, even more so to generate responses. Please keep them coming. And, as the year comes to a close, my wish is that everyone gets to enjoy a pleasant holiday season and that the upcoming year is one filled with good health, mirth, happy times with friends and family, and prosperity for us all. See you in 2025.