As we write, the fires are still raging in Los Angeles, and the devastation continues. On the other side of our country, we are preparing for the new Administration and changes that could be significant. Both instances remind us that the unexpected and improbable happen regularly. It is our job to prepare for short-term surprises in order to enjoy long-term prosperity. Knowing what to do, and when, is key.
4TH QUARTER IN REVIEW
The U.S. stock market, measured by the S&P 500, enjoyed another positive quarter, rising 3.37%, and finished the year up 25.02%.1 The equal weighted S&P 500 index was +14.7% and the NASDAQ was +29.57% for the year.2,3 Non-U.S. stock markets measured by the EAFE Index were +3.82% for 2024.4
For the fourth year running, owning bonds, measured by the Bloomberg U.S. Aggregate, +1.25%, earned less than money funds, +4.90%.5 The 10-year U.S. Treasury’s yield was higher at the end of the year than at the beginning. Not owning fixed income with more than a two-year maturity continued to be the right decision.
As hard as it is to believe, in mid-December, 5% of the companies in the S&P 500 represented more than
50% of the index.6 The top ten stocks represented 37.5%. Frankly, we have seen this movie before, and when the index was concentrated in so few names, it didn’t turn out well.
YEAR IN REVIEW
The “Magnificent Seven”—Apple, Microsoft, Alphabet, Amazon, Nvidia, Meta, and Tesla—accounted for 95% of the S&P 500 gain last year.7 The current narrative is that these large companies are the “safest” to buy because of their cash balance and dominant market share. They are dominant, and they have a lot of cash, but the mindless purchasing of these stocks through massive index fund flows has, in our opinion, introduced an underappreciated price risk. As valuations have risen, we have chosen to have less exposure to this group in recent years. Accordingly, our trailing year results lagged a bit. While we whiffed not owning more of the “Magnificent Seven,” we kept overall exposure to the stock market
relatively high while avoiding the concentration risk. Fortunately, we anticipated a few of the big trends: the growing economy, lowering of short-term interest rates, and importance of energy. During the year, we reduced some of our energy positions, specifically one of the largest global integrated “major.” We still anticipate power being a dominant theme in the years to come and plan to have exposure in a variety of ways.
On a composite basis, most of our clients enjoyed results that were higher than the equal weight S&P 500 Index, with less risk, net of fees. Our goal will always be to compound returns over time at a rate in excess of inflation, after taxes and expenses. On a relative basis, we strive to be competitive every year, but may lag in periods of high returns in an effort to protect during difficult periods.
ECONOMY
The US economy is the envy of the world. Some of the “exceptionalism” is due to our ability to deficit spend. Having the world’s reserve currency has given us a massive advantage. If we continue on this path, this advantage could be compromised. Republican or Democrat Administrations are notoriously short-sighted, only worrying about the next election cycle, knowing the more they spend the more popular they stay. It will feel good as asset prices rise and the food and drinks are “on the house.” However, the consequences that seem so far away to some remain a concern.
The risk is if the rest of the world backs away from buying our debt, interest rates will rise and that slows growth. Could that be happening now? We don’t know. We do know that almost no one notices a ship, taking on water, rides lower and goes slower until the water starts coming through the floorboards.
MARKETS
The infatuation with making “easy money” by mindlessly buying popular stocks just because they are going up is reminiscent of the fading days of bull markets. Those who remember 1999, right before the dot.com bubble burst, will remember that “Day Trading Can Lead to Big Losses, Dangerous Illusions.” In August of 2020, they were at it again, “Everyone’s a Day Trader Now.” Two years later, in October of 2022, you read “Day Traders Go Back to Their Day Jobs,” after the NASDAQ was down 32% in the first nine months.8 For calendar year 2022, the Magnificent Seven were down 45%.9
In 1999, Warren Buffett penned an article in Fortune, explaining why he felt the market valuation was high: “Mr. Buffett on the Market.”. In a nutshell, he identified that historically, corporate profits had averaged 4-6%. Compare those facts with where we are today:
- For the last 20 years, corporate profits averaged 6.2%.
In 2024, corporate profit margins were 10.1%.10 - If we went back to average corporate profit margins, stock
market valuations could drop 30-40%.
WHAT WOULD CLIFF DO?
Greenwich based hedge fund manager Cliff Asness recently published a paper, “2035 An Allocator Looks Back Over the Last Ten Years.”11 His company, AQR, is one of the more successful hedge funds with $12b in assets under management. His piece predicts what he believes the next
ten years’ returns will be:
- “…U.S. equities only beat cash by a couple of percent per annum over the whole decade, well less than we expected.”
- “Inflation ran 3-4% for the decade.”
He foretells the alternative investment industry will have been very profitable to the General Partners, like AQR and himself, and unprofitable to the investors:
“Disappointing, but Private Equity acting like equities would have been tolerable if they had actually
outperformed public markets, but they underperformed!”
Readers know we have been critical of the majority of the alternative investment industry (and the firms that promote them). A 10% gross return, less a 2% management fee and a 20% profit sharing nets the hedge fund 4% and the investor 6%. Buffett started out with a 0% management fee, 6% preference return to the investor, and took 25% of the profits above 6%. We believe this aligns interests and is more equitable. We believeWarren and Cliff will be more right than wrong.
LAND, WATER & POWER
In our recent essay, “Land, Water & Power,” we laid out that the earnings of companies could grow without the stock market index appreciating. Technological advances can lead to exuberance, which leads to P/E expansion. It is almost always followed by a period of contraction. We will leave it to history to see if the projected earnings increases promised by the efficiencies of artificial intelligence were pulled forward by 4-5 years or if stock prices can keep going unabatedly to the sky.
OUTLOOK
We do not pretend to know what will happen in the next month, quarter, or year. However, we follow larger trends because if you own wonderful companies that benefit from big trends, your odds of experiencing favorable results improve markedly. We are optimistic about the future and expect several sectors—land, water & power— to benefit from long-term secular trends.
We see no reason to change our primary views:
- Deficits of major countries will continue, total debt will grow
- Corporate profits may have peaked, P/E ratios
may contract - Adoption of artificial intelligence (AI) will drive the need
for data storage, centers and power
Corporate profits may have peaked, P/E ratios
may contract
Possible effects:
- Debasement of currency resulting in inflation is the
most plausible political choice - Crypto currency, specifically Bitcoin, will become an accepted asset class
PROMETHIUM UPDATE
As we approach our one-year anniversary as a Registered Investment Advisor, after 40 years of rehearsal, we must thank you, our clients, for your faith and trust. We know we need to earn it every day.
We have been asked to launch an investment partnership modeled after the Buffett Partnerships in the 1950s. In concept and for qualified investors only, it would be a low/no management fee, performance hurdle, and profit sharing above the performance hurdle. It is at least a tad arrogant to think that we can deliver value above an “index fund” but that is why the performance hurdles exist. If you are curious, give us a call.
CONCLUDING THOUGHTS
The debt-fueled asset price increases we have seen in just a few stocks have been like a four-year sugar rush or a teenage love affair. It does not come risk free, nor can it last forever.
Like the question Whitney Houston posed in her 1985 hit, “How Will I Know?”, we ask when, if ever, it is time to sell the “Magnificent Seven.” Like many investors today, Whitney asks because she “…loses control, can’t seem to get enough.” Asset flows into index funds and ETFs suggest Whitney is not alone.
Rational behavior at times will be out of sync with fads and frenzies and may seem old fashioned, but it works. In order to “win” we must first finish. We know we have a much better chance at finishing by taking a little less risk, carrying a little more cash, and having patience. That’s how
we will know.
Christopher F. Poch
January 14, 2025
[1] https://www.spglobal.com/spdji/en/documents/performance-reports/dashboard-sp-500-factor.pdf
[2] file:///C:/Users/Chris%20Poch/Downloads/fs-sp-500-equal-weight-index-gbp-ntr-15-wt.pdf
[3] https://www.morningstar.com/indexes/xnas/xcmp/quote
[4] https://www.msci.com/documents/10199/822e3d18-16fb-4d23-9295-11bc9e07b8ba
[5] Fidelity FDRXX ! year total return 2024.
[6] https://www.investopedia.com/best-25-sp500-stocks-8550793
[7] https://www.spglobal.com/spdji/en/documents/performance-reports/dashboard-sp-500-factor.pdf
[8] https://www.statmuse.com/money/ask/nasdaq-monthly-returns-for-2022-to-2023
[9] https://financialconnections.com/the-magnificent-7-versus-the-sp-493/
[10] https://dqydj.com/sp-500-profit-margin/
[11] https://www.aqr.com/Insights/Perspectives/2035-An-Allocator-Looks-Back-Over-the-Last-10-Years
Important Disclosures
Investment advisory services offered through Promethium Advisors, LLC, a Registered Investment Advisor with the U.S. Securities and Exchange Commission.
This material is intended for informational purposes only. It should not be construed as legal or tax advice and is not intended to replace the advice of a qualified attorney or tax advisor. This information is not an offer or a solicitation to buy or sell securities. The information contained may have been compiled from third-party sources and is believed to be reliable.
