The US markets blasted off following November’s election, as expectations of lower taxes, less corporate regulation, and an emphasis on promoting economic growth resulted in a tsunami of money rushing into stocks. In the weeks after November 5, $140 billion went into US equity funds, making November the busiest month for such money flows since 2000. The rush of excitement drove the popular market averages to numerous records, and surveys showed that fund managers had lifted their exposure to US equities to historical highs and never held less cash. A euphoric mood permeated the markets, creating almost universal expectations that the gains would continue into the new year, as reflected in sentiment data and chatter among the financial commentariat.
Despite the enthusiasm unleashed in the year’s final period, market and economic news was actually mixed, and it proved to be the best of times and worst of times for the averages, as most of November’s gains were relinquished in December. The Dow Jones Industrial Average went on to experience its longest losing streak since 1974. And while the economic picture looked reasonably good overall—especially when compared with those of other economies—on corporate earnings calls, CEOs spoke frequently of an industrial recession affecting their companies’ financial results. As has been the case for the last couple of years, much of the seemingly extraordinary US economic performance relative to other countries was due to a small number of firms in the technology sector, without which the US economy’s enviable performance would have been far less impressive. Furthermore, the fact that the shares of one company, Nvidia, accounted for about 25% of the S&P 500’s gains in 2024, makes the US market performance seem much less solid. America’s vast and growing “leverage” (debt) acted to enhance economic results as well, but it is also a significant risk factor, making the US a not-so-great role model for economies with more conservative financial policies.
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“American exceptionalism” has become the phrase du jour among market observers, with some justification. Even with the concentration in technology, US economic growth has exceeded that of other industrial nations since the pandemic, as have the returns generated in its financial markets. Additionally, America’s “safe haven” status in a world full of uncertainty and political turmoil has made the US the go-to market for global asset managers; the $140 billion that moved into US securities was accompanied by financial outflows in most other regions. Nothing spells confidence like money.
The near total uniformity of outlook for US financial markets has raised concern among a few observers and market participants, as such a “cheery consensus” magnifies the disappointment that occurs when events turn out differently than expected, as is often the case. In an unusually contrary piece in the Financial Times entitled “How the ‘mother of all bubbles’ will pop,” Ruchir Sharma of Rockefeller International writes how the fascination with a perceived American market exceptionalism has blinded analysts to the actual history of US market behavior over time. In the 2000s, for example, US stocks returned 0% while some foreign markets tripled in value. Longer term, US stock market results were decidedly unexceptional during six of the past eleven decades. Sharma also notes the fact that risks build as trends become established and continue for an extended time (a principle well-known to readers of Hyman Minsky). Sharma concludes, “All the classic signs of extreme prices, valuations and sentiment suggest that the end is near.”
Sharma’s expectation that the current bull market is about to come to an end is not unlike the predictions one gets from pundits at this time of year, but what sets it apart is an evaluation of risk that is consistent with actions taken by prominent investors over the past year. Buffett, for example, has permitted his Berkshire Hathaway to accumulate unprecedented amounts of cash (totaling hundreds of billions of dollars), a telling assessment of risk by someone who is often early in his judgments, but seldom wrong. Likewise, the decision by PIMCO, a prominent bond fund manager, to avoid long term US treasury securities is also a risk evaluation worth paying attention to. Such moves seldom grab the public’s attention, but real investors making investment decisions are always a more credible source of market wisdom than the musings of often conflicted opinionators. No one knows how near the end is. Recognizing risk (and opportunity) and acting accordingly is what distinguishes these decision-makers.
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When we began working on Wall Street in the summer of 1982, the Dow Jones Industrial Average stood at less than 800 (vs 43,000 today!), and the prevailing fear was that it would go lower still. The “Dow” had previously peaked at 1000 a few times beginning in 1966, but during the fifteen years preceding my summer sojourn in New York it had gone nowhere (although dividends were generous during the period). The investing public had come to view stocks as a scarcely investable asset class; the infamous “The Death of Equities” article had appeared in Businessweek in 1979. Investors sought alternatives, including speculation in stock options, commodities, and futures markets (the Hunt brothers’ cornering of the silver market occurred at this time). Despite widespread negativity about stock ownership, in August of 1982 one of the most powerful market upswings in history began that, arguably, continues to this day. Not only did the negative consensus lead many investors (including professionals) to avoid an asset that was, in reality, exceptionally investable, a suddenly buoyant market caused heavy selling, into what some market participants thought was only a short-term rally.
That initial introduction to a financial market straddling the line between bear market funk and bullish excitement was an invaluable experience for someone new to the field. From the beginning we were made aware that predictions are a poor way to make investment decisions. It was our first exposure to the idea that inactivity in investing can be a virtue, indeed, simply staying the course allowed investors to benefit from the long-term upswing in business values. We also learned that markets are indifferent to human wishes and can be very unfriendly, or friendly when you least expect it.
In reality, market predictions amount to a kind of temperature reading, gauging current sentiment, rather than a calculation of trajectory like mathematics can calculate the flightpath of a space probe. Returning to Sharma’s article, this excerpt describes this idea very well:
“Virtually every Wall Street analyst predicts US stocks will continue
outperforming the rest of the world in 2025. But all this enthusiasm only
tends to confirm that the bubble is at a very advanced stage. If the
consensus on ‘American exceptionalism’ is so overwhelming, who is left to
hop on the bandwagon and inflate it further?
The certainty of Wall Street has spilt over into the popular media, which
often picks up on market trends only when they are well established and near
an end. Hype for American superiority is now the stuff of TV, radio,
podcasts, newspaper columns and magazine cover stories, which have a record
of pointing the wrong way on future trends.”
Sharma’s last point explains why a person whose knowledge of financial matters comes mostly through news media often finds market moves mysterious and counter-intuitive; by the time significant data and judgements about business prospects appear in the media, these factors have already been incorporated into security prices.
Market ebullience does not appear to have dissipated as a result of December’s givebacks, at least not to a great extent. In contrast with the situation in 1982, four decades of gains means that nowadays, everyone wants to own stocks. People see setbacks are buying opportunities, and don’t see rallies as chances to sell. For this reason, “the end is near” may yet be quite a ways off.
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“The phenomenon is so new, we still don’t necessarily even have the vocabulary for it. This is something that quite literally didn’t happen two decades ago.” This remark, from a scientist at the Woods Hole Oceanographic Institution in Massachusetts, is not welcome if you are trying to buy homeowner flood insurance in the southeast and Gulf coastal areas of the US, where sea levels have risen six to eight inches since 2010, which is more than what occurred for several decades prior. Nor is it encouraging news for insurance companies underwriting such coverage, some of which have stopped doing business in the region or gone out of business entirely.
Insurance is a sometimes-controversial industry that in another context has lately come in for criticism. What we find interesting about the business is the fact that it devotes considerable resources to the study and evaluation of risks. The future is difficult to predict, but very smart people at insurance companies apply their considerable skills and experience to assessing probabilities of events; the accuracy of these assessments can make the difference between whether their companies thrive or fail. Hence during the last few years we have paid close attention to developing financial risk in the US property sector as reflected in insurance markets.
Lest anyone think that rising financial risk related to property damage is limited to areas prone to hurricanes or wildfires that are already facing a crisis, consider this: fully 99% of counties in the US have experienced flooding during the last quarter century, and only 6% of homes have flood insurance. Also, 40% of flood insurance claims have come from areas that are not at high risk for flooding. Coming to a theatre near you?
Happy New Year!
Dennis Butler, MBA, CFA
Commentary