Reflecting on the stock market's headwind-defying run 📈
Plus a charted review of the macro crosscurrents 🔀
📈The stock market climbed to all-time highs, with the S&P 500 setting an intraday high of 6,128.18 on Friday and a closing high of 6,118.71 on Thursday. The index gained 1.7% last week to close at 6,101.24. It’s now up 3.7% year to date and up 70.6% from its October 12, 2022 closing low of 3,577.03.
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After hitting a few bumps over the past month, the bull market resumed and stocks hit record highs last week.
This happened despite some notable headwinds intensifying in recent months.
Long-term interest rates, while off their highs, remain above levels we’ve experienced in recent years. This is a headwind for anyone needing to borrow money or refinance debt.
On the short end of the yield curve, expectations for rate cuts from the Federal Reserve have been coming down, a hawkish development that has market bears salivating.
The U.S. dollar, meanwhile, has appreciated significantly against many major foreign currencies. This is a headwind for multinational U.S.-based corporations doing a lot of business in non-U.S. markets.
All of this has been occurring as valuation metrics like the price-to-earnings (P/E) ratio suggest the stock market is expensive relative to history.
Higher interest rates, fewer Fed rate cuts, a strengthening dollar, and elevated valuation ratios are all things that many market pundits will cite as reasons to be cautious on the stock market.
While it’s fair to argue these developments are indeed challenges, none of it means prices must fall.
The bottom line 🤔
There are plenty of reasons to explain why the stock market would trend higher despite the challenges. Maybe the market expects the headwinds to be short-lived. Maybe the market expects these headwinds to be offset by other tailwinds. Maybe the market is just being irrational right now and will correct in the near future.
Something I’ve been stressing in recent pieces about interest rates, Fed rate cuts, and the dollar is that none of them will reliably signal where the stock market is headed in the next year.
And importantly, each one is just one of many forces that can affect the outlook for earnings growth — which is the most important driver of stock prices. As I laid out in TKer Stock Market Truth No. 5: “News about the economy or policy moves markets to the degree they are expected to impact earnings. Earnings (a.k.a. profits) are why you invest in companies.“
Two weeks into Q4 earnings season, most companies are reporting results that are beating expectations. And the outlook for earnings growth continues to be very positive.
Critically, this has been supported by robust profit margins. Companies have been reporting improving profit margins in Q4, and analysts continue to forecast fatter profit margins in the quarters to come.
Corporate executives and industry analysts all seem to agree that business prospects continue to look up.
For investors, the question is not whether some development will be a headwind for the stock market. Rather, investors should be asking if the companies underlying the market can overcome the headwind and deliver on earnings.
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Related from TKer:
'How many times will the Fed cut rates?' is not the right question 🔪
'There is no evidence of mean reversion in equity valuations' 🤯
Review of the macro crosscurrents 🔀
There were several notable data points and macroeconomic developments since our last review:
💳 Card spending data is holding up. From JPMorgan: “ As of 17 Jan 2025, our Chase Consumer Card spending data (unadjusted) was 4.8% above the same day last year. Based on the Chase Consumer Card data through 17 Jan 2025, our estimate of the US Census January control measure of retail sales m/m is 0.66%.”
From BofA: “Total card spending per HH was up 5.6% y/y in the week ending Jan 18, according to BAC aggregated credit & debit card data. The South & MW saw a large y/y rise in total card spending, payback for the snowstorm-driven decline in the previous week.“
For more on the consumer, read: Americans have money, and they plan to spend it 🎁
👎 Consumer vibes sour. From the University of Michigan’s January Surveys of Consumers: “Consumer sentiment fell for the first time in six months, edging down 4% from December. While assessments of personal finances inched up for the fifth consecutive month, all other index components pulled back. Indeed, sentiment declines were broad based and seen across incomes, wealth, and age groups.”
Consumer sentiment readings have lagged resilient consumer spending data. For more on this contradiction, read: What consumers do > what consumers say 🙊 and We're taking that vacation whether we like it or not 🛫
Politics clearly plays a role in peoples’ perception of the economy. Just look at inflation expectations by party affiliation.
For more on how politics affects sentiment, read: Beware how your politics distort how you perceive economic realities 😵💫
🏚 Home sales rise. Sales of previously owned homes increased by 2.2% in December to an annualized rate of 4.24 million units. From NAR chief economist Lawrence Yun: “Home sales during the winter are typically softer than the spring and summer, but momentum is rising with sales climbing year-over-year for three straight months. Consumers clearly understand the long-term benefits of homeownership. Job and wage gains, along with increased inventory, are positively impacting the market.”
💸 Home prices rise. Prices for previously owned homes declined from last month’s levels but were above year ago levels. From the NAR: “The median existing-home sales price progressed 6.0% from December 2023 to $404,400, the 18th consecutive month of year-over-year price increases and biggest year-over-year growth since October 2022 (+6.5%). All four U.S. regions posted price increases.”
🏠 Mortgage rates tick lower. According to Freddie Mac, the average 30-year fixed-rate mortgage declined to 6.96% from 7.04% last week. From Freddie Mac: “After crossing the 7%-mark last week, the 30-year fixed-rate mortgage saw its first decline in six weeks. While affordability challenges remain, this is welcome news for potential homebuyers, as reflected in a corresponding uptick in purchase applications.”
There are 147 million housing units in the U.S., of which 86.6 million are owner-occupied and 34 million (or 40%) of which are mortgage-free. Of those carrying mortgage debt, almost all have fixed-rate mortgages, and most of those mortgages have rates that were locked in before rates surged from 2021 lows. All of this is to say: Most homeowners are not particularly sensitive to movements in home prices or mortgage rates.
For more on mortgages and home prices, read: Why home prices and rents are creating all sorts of confusion about inflation 😖
⛽️ Gas prices rise. From AAA: “Despite easing oil costs and lackluster domestic gasoline demand, pump prices eked out a three-cent gain since last week to $3.13. …According to new data from the Energy Information Administration (EIA), gasoline demand fell from 8.32 million b/d last week to an anemic 8.08 million. Meanwhile, total domestic gasoline stocks rose from 243.6 million barrels to 245.9, while gasoline production decreased last week, averaging 9.2 million barrels per day.”
For more on energy prices, read: Higher oil prices meant something different in the past 🛢️
💼 Unemployment claims tick up. Initial claims for unemployment benefits rose to 223,000 during the week ending January 18, up from 217,000 the week prior. This metric continues to be at levels historically associated with economic growth.
For more on the labor market, read: The labor market is cooling 💼
😬 This is the stuff pros are worried about. According to BofA’s January Global Fund Manager Survey: “41% of January FMS respondents say inflation causing the Fed to hike is the biggest 'tail risk', followed by a recessionary trade war.”
For more on risks, read: Three observations about uncertainty in the markets 😟 and Two times when uncertainty seemed low and confidence was high 🌈
🏢 Offices remain relatively empty. From Kastle Systems: “Peak day office occupancy was 61.6% on Tuesday, up more than five points from the previous week as workers continued to return to the office after the holidays. The average low was on Friday at 30.6%, up 4.3 points from last week.”
For more on office occupancy, read: This stat about offices reminds us things are far from normal 🏢
🇺🇸 Surveys point to cooling growth. From S&P Global’s January Flash U.S. PMI: “US businesses are starting 2025 in an upbeat mood on hopes that the new administration will help drive stronger economic growth. Rising optimism is most notable in the manufacturing sector, where expectations of growth over the coming year have surged higher as factories await support from the new policies of the Trump administration, though service providers are also entering 2025 in good spirits. Although output growth slowed slightly in January, sustained confidence suggests that this slowdown might be short-lived.“
Keep in mind that during times of perceived stress, soft survey data tends to be more exaggerated than actual hard data.
For more on this, read: What businesses do > what businesses say 🙊
📈 Near-term GDP growth estimates remain positive. The Atlanta Fed’s GDPNow model sees real GDP growth climbing at a 3.0% rate in Q4.
For more on the economy, read: 9 once-hot economic charts that cooled 📉
Putting it all together 🤔
The long-term outlook for the stock market remains favorable, bolstered by expectations for years of earnings growth. And earnings are the most important driver of stock prices.
Demand for goods and services is positive, and the economy continues to grow. At the same time, economic growth has normalized from much hotter levels earlier in the cycle. The economy is less “coiled” these days as major tailwinds like excess job openings have faded.
To be clear: The economy remains very healthy, supported by strong consumer and business balance sheets. Job creation remains positive. And the Federal Reserve — having resolved the inflation crisis — has shifted its focus toward supporting the labor market.
We are in an odd period given that the hard economic data has decoupled from the soft sentiment-oriented data. Consumer and business sentiment has been relatively poor, even as tangible consumer and business activity continue to grow and trend at record levels. From an investor’s perspective, what matters is that the hard economic data continues to hold up.
Analysts expect the U.S. stock market could outperform the U.S. economy, thanks largely due to positive operating leverage. Since the pandemic, companies have adjusted their cost structures aggressively. This has come with strategic layoffs and investment in new equipment, including hardware powered by AI. These moves are resulting in positive operating leverage, which means a modest amount of sales growth — in the cooling economy — is translating to robust earnings growth.
Of course, this does not mean we should get complacent. There will always be risks to worry about — such as U.S. political uncertainty, geopolitical turmoil, energy price volatility, cyber attacks, etc. There are also the dreaded unknowns. Any of these risks can flare up and spark short-term volatility in the markets.
There’s also the harsh reality that economic recessions and bear markets are developments that all long-term investors should expect to experience as they build wealth in the markets. Always keep your stock market seat belts fastened.
For now, there’s no reason to believe there’ll be a challenge that the economy and the markets won’t be able to overcome over time. The long game remains undefeated, and it’s a streak long-term investors can expect to continue.
For more on how the macro story is evolving, check out the the previous TKer macro crosscurrents »
Key insights about the stock market 📈
Here’s a roundup of some of TKer’s most talked-about paid and free newsletters about the stock market. All of the headlines are hyperlinked to the archived pieces.
10 truths about the stock market 📈
The stock market can be an intimidating place: It’s real money on the line, there’s an overwhelming amount of information, and people have lost fortunes in it very quickly. But it’s also a place where thoughtful investors have long accumulated a lot of wealth. The primary difference between those two outlooks is related to misconceptions about the stock market that can lead people to make poor investment decisions.
The makeup of the S&P 500 is constantly changing 🔀
Passive investing is a concept usually associated with buying and holding a fund that tracks an index. And no passive investment strategy has attracted as much attention as buying an S&P 500 index fund. However, the S&P 500 — an index of 500 of the largest U.S. companies — is anything but a static set of 500 stocks.
The key driver of stock prices: Earnings💰
For investors, anything you can ever learn about a company matters only if it also tells you something about earnings. That’s because long-term moves in a stock can ultimately be explained by the underlying company’s earnings, expectations for earnings, and uncertainty about those expectations for earnings. Over time, the relationship between stock prices and earnings have a very tight statistical relationship.
Stomach-churning stock market sell-offs are normal🎢
Investors should always be mentally prepared for some big sell-offs in the stock market. It’s part of the deal when you invest in an asset class that is sensitive to the constant flow of good and bad news. Since 1950, the S&P 500 has seen an average annual max drawdown (i.e., the biggest intra-year sell-off) of 14%.
High and rising interest rates don't spell doom for stocks👍
Generally speaking, rising interest rates are not welcome news for the economy and the stock market. They represent higher financing costs for businesses and consumers. All other things being equal, rising rates represent a hindrance to growth. However, the world is complicated, and this narrative comes with a lot of nuance. One big counterintuitive piece to this narrative is that historically, stocks have actually performed well during periods of rising interest rates.
How stocks performed when the yield curve inverted ⚠️
There’ve been lots of talk about the “yield curve inversion,” with media outlets playing up that this bond market phenomenon may be signaling a recession. Admittedly, yield curve inversions have a pretty good track record of being followed by recessions, and recessions usually come with significant market sell-offs. But experts also caution against concluding that inverted yield curves are bulletproof leading indicators.
How the stock market performed around recessions 📉📈
Every recession in history was different. And the range of stock performance around them varied greatly. There are two things worth noting. First, recessions have always been accompanied by a significant drawdown in stock prices. Second, the stock market bottomed and inflected upward long before recessions ended.
In the stock market, time pays ⏳
Since 1928, the S&P 500 generated a positive total return more than 89% of the time over all five-year periods. Those are pretty good odds. When you extend the timeframe to 20 years, you’ll see that there’s never been a period where the S&P 500 didn’t generate a positive return.
What a strong dollar means for stocks 👑
While a strong dollar may be great news for Americans vacationing abroad and U.S. businesses importing goods from overseas, it’s a headwind for multinational U.S.-based corporations doing business in non-U.S. markets.
Economy ≠ Stock Market 🤷♂️
The stock market sorta reflects the economy. But also, not really. The S&P 500 is more about the manufacture and sale of goods. U.S. GDP is more about providing services.
Stanley Druckenmiller's No. 1 piece of advice for novice investors 🧐
…you don't want to buy them when earnings are great, because what are they doing when their earnings are great? They go out and expand capacity. Three or four years later, there's overcapacity and they're losing money. What about when they're losing money? Well, then they’ve stopped building capacity. So three or four years later, capacity will have shrunk and their profit margins will be way up. So, you always have to sort of imagine the world the way it's going to be in 18 to 24 months as opposed to now. If you buy it now, you're buying into every single fad every single moment. Whereas if you envision the future, you're trying to imagine how that might be reflected differently in security prices.
Peter Lynch made a remarkably prescient market observation in 1994 🎯
Some event will come out of left field, and the market will go down, or the market will go up. Volatility will occur. Markets will continue to have these ups and downs. … Basic corporate profits have grown about 8% a year historically. So, corporate profits double about every nine years. The stock market ought to double about every nine years… The next 500 points, the next 600 points — I don’t know which way they’ll go… They’ll double again in eight or nine years after that. Because profits go up 8% a year, and stocks will follow. That's all there is to it.
Warren Buffett's 'fourth law of motion' 📉
Long ago, Sir Isaac Newton gave us three laws of motion, which were the work of genius. But Sir Isaac’s talents didn’t extend to investing: He lost a bundle in the South Sea Bubble, explaining later, “I can calculate the movement of the stars, but not the madness of men.” If he had not been traumatized by this loss, Sir Isaac might well have gone on to discover the Fourth Law of Motion: For investors as a whole, returns decrease as motion increases.
Most pros can’t beat the market 🥊
According to S&P Dow Jones Indices (SPDJI), 59.7% of U.S. large-cap equity fund managers underperformed the S&P 500 in 2023. As you stretch the time horizon, the numbers get even more dismal. Over a three-year period, 79.8% underperformed. Over a 10-year period, 87.4% underperformed. And over a 20-year period, 93% underperformed. This 2023 performance follows 13 consecutive years in which the majority of fund managers in this category have lagged the index.
Proof that 'past performance is no guarantee of future results' 📊
S&P Dow Jones Indices found that funds beat their benchmark in a given year are rarely able to continue outperforming in subsequent years. For example, 334 large-cap equity funds were in the top half of performance in 2021. Of those funds, 58.7% came in the top half again in 2022. But just 6.9% were able to extend that streak through 2023. If you set the bar even higher and consider those in the top quartile of performance, just 20.1% of 164 large-cap funds remained in the top quartile in 2022. No large-cap funds were able to stay in the top quartile for the three consecutive years ending in 2023.
The odds are stacked against stock pickers 🎲
Picking stocks in an attempt to beat market averages is an incredibly challenging and sometimes money-losing effort. In fact, most professional stock pickers aren’t able to do this on a consistent basis. One of the reasons for this is that most stocks don’t deliver above-average returns. According to S&P Dow Jones Indices, only 24% of the stocks in the S&P 500 outperformed the average stock’s return from 2000 to 2022. Over this period, the average return on an S&P 500 stock was 390%, while the median stock rose by just 93%.
