October 26, 2024 Market Update

The six-week winning streak for the S&P 500 Index and the Dow ended this past week as the indexes posted roughly 1% and 2.7% of losses, respectively.  The small-cap stocks, as measured by the Russell 2000 Index, were also down 3%.  The tech-heavy Nasdaq, on the other hand, trended modestly higher to close in on its all-time record high set in July 2024. 

The bond market remained volatile in the wake of continuation of stronger-than-expected economic data.  The 10-year Treasury yields surged higher by 16 bps during the week, resulting in a 0.92% drop for the Vanguard Total Bond Market ETF, a proxy for the overall U.S. bond market.

The U.S. stock market is on pace for one of its best years ever, with the S&P 500 having already reached 47 all-time highs since the start of 2024.  According to a recent Bloomberg survey of 411 market observers, stocks are expected to extend their rally through the end of the year, with their median estimate predicting the S&P 500 will hit 6,000 by year-end.

 That said, it's important to note that higher stock prices often lead to lower expected returns going forward, and at the moment U.S. stocks appear quite expensive by historical standards.  The CAPE (Cyclically Adjusted Price-to-Earnings) ratio, a widely followed indicator of long-term market value, suggests that the S&P 500 is more expensive today than it was just before the 1929 crash and not far from its peak during the dot-com bubble of 2000.

 Furthermore, U.S. stocks are trading at much higher valuations compared to international markets.  Key metrics like the price-to-earnings (P/E) ratio and the CAPE ratio indicate that stocks in developed markets, such as Europe, and emerging markets are priced more attractively than U.S. equities.

 Additionally, U.S. equities are expensive relative to bonds.  The “Excess CAPE Yield” - which compares the earnings yield of stocks to the yield of 10-year Treasury bonds - suggests that U.S. stocks may struggle to outperform bonds in the coming years.

 I do not put much stock in predictions on what the stock market will do next.  However, I did find Goldman Sachs announcement last week that it expects U.S. stocks will post an annual return of just 3% over the next decade, or about 1% after accounting for inflation interesting.  Goldman also estimates a more than 70% chance that U.S. Treasuries will beat stocks in that time frame.  While I believe Goldman’s forecast is overly pessimistic, barring an economic crisis of some sort, it underscores the importance of maintaining a diversified portfolio that is systematically adjusted to reflect changing market and economic conditions.

 In the short term, strong momentum and investor sentiment could keep the market rally going.  But looking further ahead, U.S. stocks face significant headwinds that could limit their ability to outperform over the next decade.

 That’s all for now.  Have a great weekend and invest wisely, my friends.