INSIGHTS

January 31, 2025

Q & Amy

Edition 14

Angus: When the calendar turns to January, Wall Street strategists often publish their year-ahead predictions. Some are predicting an S&P 500 market correction. What are your thoughts?

Amy: Strategist forecasts help investors analyze and navigate the market ahead, yet it is just a regularly scheduled, annual prediction. Most forecasts are adjusted throughout the year.

US stocks are highly valued, particularly in the technology sector. The price-to earnings (P/E) ratio for the S&P 500 was 16.7x at the end of 2022. Now it is 22.0x, which led to a 58% two-year cumulative return for the Index. A pullback in stocks is certainly possible.

Angus: What led to the higher valuation (P/E ratio)?

Amy Bush, CFA

Chief Investment Officer

C. Angus Schaal, CFP^®

Senior Managing Director

Amy: The economy has been stronger than expected. Inflation fell from 10% to a more normal level, employment has held up better than expected due to all the fiscal stimulus still flowing through the economy, the Fed started easing, and the US election is behind us. S&P 500 earnings grew 12% year-over-year in 2024 compared to 6% in 2023, with the mega-caps doing the heavy lifting. Artificial intelligence has emerged as the most dominant investing theme with the promise of extraordinary productivity gains.

Small and mid-sized companies have also experienced an increase in valuation over the past year but without earnings growth.

Angus: What are investors’ biggest concerns?

Amy: Quite a bit of good news has been accounted for in stock prices, and rightfully so. GDP grew 3% last year, and labor has held up well. Productivity is the best it has been since the 90s dot.com boom. But policy uncertainty is certainly worrying investors.

When stocks are expensive compared to the past, it doesn’t take much for them to fall. Investors are concerned about inflation re-igniting and bond yields (long-term) continuing to rise. Uncertainty in terms of trade, tariffs, and immigration have consequences in terms of inflation and growth. Governments around the world are spending too much. Geopolitical concerns are numerous.

Angus: How do you protect the portfolio against a market (bonds and stocks) correction?

Amy: Markets don’t rise in a straight line. Corrections are a natural part of market cycles that we expect. We consider pullbacks to be opportunities. Most portfolio managers maintain a “wish list” – assets they would buy on a strong pullback in price. Yet predicting the exact timing of a market downturn is nearly impossible on a consistent basis. Consequently, maintaining a diversified portfolio is the best protection for investors against adverse market movements. Tandem’s stock portfolios are diversified by size (large, medium, and small), geography (developed and emerging), and economic sector (11 sectors). Bonds are diversified by credit and maturity.

The S&P 500 is a very concentrated index. While it is considered “the market” by most professionals, investors must be aware of the technology sector concentration at over 1/3 of the weight of the index. While technology stocks have some of the strongest balance sheets and some of the best growth prospects in US markets, they should be portion of a well-diversified portfolio.

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