December 27, 2024
By Steve Blumenthal
“Value investing is the discipline of buying securities at a significant discount to their underlying value and holding them until more of their value is realized. The concept is simple, but the execution can be challenging.“
– Seth Klarman, Baupost Capital Management
As the calendar turns to a new year, I wish you joy, health, abundance and heartwarming moments with the people you love most. Happy New Year!
Here is a quick reflection on 2024 and a look forward to ’25. Let’s begin with the Fed, since they control the price of money. Right or wrong, good or bad, it’s all about the Fed.
Chairman Powell and his team raised interest rates 11 times between March 2022 and July 2023. They have cut rates three times in 2024: 50 bps in September, 25 bps in November, and 25 bps in December. According to @ZeroHedge, it is the first time in history that 100 bps points in Fed rate cuts have seen a 100 bps increase in the 10-year Treasury yield. What makes this time different is $36 trillion in U.S. Government Debt. The interest expense on the government’s books is now problematic, to say the least.
I expected a recession in 2024. There was no recession. I expected stock market valuations to revert to the long-term trend. That didn’t happen. I didn’t expect Janet Yellen’s Treasury to spend an extra $2 trillion financed via Treasury Bill issuance. That kicked the recession-can another few turns down the road. Click here for the December 2023 On My Radar titled, The Fed, Inflation, Recession, and Market Valuations.
In 2023, Wall Street analysts provided various predictions for the S&P 500 Index’s target levels for the end of 2024, ranging from 4,500 to 5,400. They all undershot the mark. Here’s a summary of some of those forecasts:
- Goldman Sachs forecasted the S&P 500 to end 2024 at 4,700, representing a 5% price gain from the current level and a 6% total return, including dividends.
- Morgan Stanley had a more cautious outlook with a target of 4,500 for the S&P 500 by the end of 2024, implying no upside from the current level as of November 2023.
- Fundstrat’s Tom Lee was notably bullish, predicting the S&P 500 would reach 5,200 by the end of 2024, suggesting a potential upside of 9% from the levels in late 2023.
- Oppenheimer expected a gain of at least 13% with a target of 5,400, based on an earnings projection of $240 per share and a price-to-earnings multiple of 21.7x.
- Deutsche Bank had a forecast of 4,500, similar to Morgan Stanley’s conservative view.
- BMO Capital Markets anticipated a 5,100 target, suggesting a 9% gain from late 2023 levels.
- RBC Capital Markets forecasted the index at 4,900, indicating a 7.5% average gain in presidential election years.
Source: Forbes, Business Insiders, Business Insiders.
The S&P 500
The truth is, predictions are just guesses, no matter how fancy the math is. The world’s too messy to be certain of anything.
I love the Charlie Munger quote: “Extreme patience combined with extreme decisiveness. You may call that our investment process. Yes, it’s that simple.”
I’m sure you know Munger’s partnership and great friendship with Warren Buffett. Buffett was a student of Benjamin Graham at Columbia Business School and later worked for him at Graham-Newman Corporation. Buffett has often cited Graham’s teachings as fundamental to his investment philosophy. He has specifically mentioned how Graham’s principles of buying stocks at a significant discount to their intrinsic value shaped his approach.
Although Charlie Munger was not a direct student of Graham, he was significantly influenced by Graham’s work during his partnership with Buffett. Munger helped evolve Buffett’s strategy from rigid Graham-style investing to a more nuanced approach, for example, considering a company’s qualitative aspects, like its management and business model.
Buffett once said, “By far the best book on investing ever written is Benjamin Graham’s The Intelligent Investor.”
It’s extremely hard to find value when the market sits at record-high valuations. I imagine this is why Berkshire Hathaway is sitting on so much cash…
Let’s take a look at current conditions and make a few practical and actionable predictions
Inflation is a challenge, recession has been avoided (so far), and market valuations have become more extreme. Debt remains the big elephant in the room and may explain why the 10-year Treasury moved up by 1% in the face of the Fed cutting the Fed Funds rate by 1%.
Source: @zerohedge
A recession in 2025 remains a high probability. As you’ll see below, stock market corrections average -36% during recessions. A 36% decline from 6,000 puts the S&P 500 Index around 3,600.
If we’ve gathered anything today, it’s that predicting the future is not so simple. Three things in particular trouble me: Investor concentration, valuations, and statistics around recessions.
Concentration
It’s easy to see that investors are highly concentrated in just a few stocks, The Magnificent Seven, for example. However, look at the Top 10 stocks in the following chart.
The top ten stocks make up nearly 40% of the market. The top ten stocks at the height of the “Tech Bubble” in 2000 made up 26%. This is what the bubble today looks like:
Valuations
Valuations, by almost every measure, are at record highs. My favorite is what is now known as the Buffett Indicator. We’ll examine that in next week’s OMR. The following chart, courtesy of John Hussman, is an excellent measure as well.
The all-time high valuation math shakes out poorly. Hussman surveyed the valuation data back to 1928. With valuation level being the starting condition, he plotted the actual subsequent 12-year S&P 500 average annual total returns (represented by each blue dot). The arrow at the bottom right-hand side of the chart is the current expected yearly return based on the starting valuation conditions, which is associated with the arrow in the upper right-hand corner of the above chart.
Forecast: Cloudy with a chance of -6% yearly for the next 12 years.
Source: HussmanFunds
The great value investor Benjamin Graham put it best: “In the short run, the market is a voting machine, but in the long run, it is a weighing machine.”
Look again at the blue dots in the chart and note where the vertical line in the middle intersects the 10% annual return line. Think of the center point in the chart as “fair value.” We’d have a different conversation if that were today’s starting condition.
Recessions
I came across this next chart in X. It shows the average correction without a recession, the average of all corrections, and the average correction in a recession, looking at data since 1965, measured in depth of decline and number of days.
Source: Click on the chart to go to the Source. @Callum_Thomas is a good follow.
I want to circle back to investor concentration for a moment. There is so much money invested in so few stocks. The warning is clear as day. Yes, it’s hard not to love the following companies, but the question is, at what price point?
As of December 27, 2024, according to Reuters and Market Watch, the top ten U.S. companies by market capitalization are:
- Apple Inc. (AAPL) – Approximately $3.915 trillion.
- NVIDIA Corporation (NVDA) – Approximately $3.426 trillion.
- Microsoft Corporation (MSFT) – Approximately $3.257 trillion.
- Alphabet Inc. (GOOGL) – Approximately $2.058 trillion.
- Amazon.com, Inc. (AMZN) – Approximately $1.956 trillion.
- Meta Platforms, Inc. (META) – Approximately $1.448 trillion.
- Berkshire Hathaway Inc. (BRK.A) – Approximately $993 billion.
- Tesla, Inc. (TSLA) – Approximately $835 billion.
- Broadcom Inc. (AVGO) – Approximately $805 billion.
- Taiwan Semiconductor Manufacturing Company (TSM) – Approximately $900 billion.
Source: Reuters and MarketWatch. Rankings are based on current stock prices and outstanding shares.
Think about this: as of December 27, 2024, the S&P 500 Index is worth ~$50 trillion. The Total U.S. Stock Market is worth ~$55 trillion. The Total Global Stock Market is worth ~ $115 trillion. Just ten stocks comprise 40% of the top 500 U.S. stocks. $20 trillion in ten stocks and $30 trillion in the remaining 490 stocks. The ten stocks comprise approximately 35% of the Total U.S. Stock Market and roughly 17% of the Total Global Stock Market. The momentum is good… as long as money keeps flowing into the market.
Whatever the trigger, I’m confidently predicting that investors will misbehave, panic will rule reason, and valuations will revert to the historical trend line and below it. I predict we’ll see Bob Farrell’s rule #2: “Excess moves in one direction will lead to an excess move in the opposite direction.” When? Don’t know.
There are better ways, in my view, to earn 10% or better returns without taking stock market risk. If you must be in the market, some downside risk management protection seems as mandatory as buying fire insurance on your home. Write the insurance check, and keep Charlie Munger and Warren Buffett’s investment mantra top of mind: “Extreme patience and extreme decisiveness.”
2025 Game Plan: Median Fair Value in the S&P 500 Index is at approximately 3,800. If we see panic, we’ll likely see excess in the opposite direction.
We’ll feel it when it happens. I’ll be on the lookout for panic, then decisiveness!
Bob Farrell is one of my investment heroes. He was the Chief Technician at Merrill Lynch and played a significant role in guiding the firm’s investment outlook. I listened to him as a young advisor at Merrill Lynch in the 1980s. He had a profound influence on my career.
Grab that coffee and find your favorite chair. Below, you’ll find Bob Farrell’s famous “10 Rules,” some sage advice from Buffett on the value of reputation, and Jensen Huang, NVIDIA CEO, on the importance of resilience. Fantastic!
On My Radar:
- 2025 Recession
- Bob Farrell’s 10 Rules
- Trade Signals: December 26, 2024 Update
- Personal Note: Reputation and Resilience
See Important Disclosures at the bottom of this page. Reminder: This is not a recommendation to buy or sell any security. My views may change at any time. The information is for discussion purposes only.
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2025 Recession
Since November 1, 2023, the odds of a recession beginning in 2025 have HALVED, from 54% to 27%, according to @Kalshi.
I predict recession odds are much higher than that. I shared the next chart with Trade Signals subscribers this week. The orange line in the middle tracks the yield difference between the 6-month Tsy Bill and the 10-year Tsy Note. Over time, it is normal for longer-term yields to be higher than shorter-term yields. You should be paid more for something you hold for a longer time.
But, if the economy catches the flu, the reverse can be true. When the orange line dips below the horizontal dotted black line, it indicates something is wrong in the system.
The grey vertical bars plot periods of recession. Interestingly, recessions tend to follow periods where the short-term yield is higher than the long-term yield. We geeks call it an inverted yield curve. Historically, the median lead time for this before a recession started was 11 months. We have now gone 29 months (data through November 30, 2024) without a recession.
What’s more important to note is that recessions occurred after the yield curve normalized- that’s when the orange line moved back above the dotted black line (not small red up-pointing arrows).
Guess what: the cross above just occurred in mid-December. When I update this same chart with data through 12-31-24, it will reflect the orange line above the dotted black line. I’m putting recession odds in 2025 at 75%, with recession beginning sometime in the first half of the year—my prediction. No guarantees. I could be wrong, but the historical odds are in my favor.
Bob Farrell’s 10 Rules
Source: StockCharts.com (Click on the link to view charts with text. I provide a summary below.)
Wall Street veteran Bob Farrell of Merrill Lynch teaches investors to think outside the box with his 10 rules of investing.
Bob Farrell’s Market Rules
Bob Farrell is a Wall Street veteran who draws on 50 years of experience crafting his investing rules. After finishing a master’s program at Columbia Business School, he launched his career as a technical analyst with Merrill Lynch in 1957. Even though Mr. Farrell studied fundamental analysis under Gramm and Dodd, he turned to technical analysis after realizing there was more to stock prices than balance sheets and income statements. He became a pioneer in sentiment studies and market psychology.
His 10 rules on investing stem from decades of personal experience with dull markets, bull markets, bear markets, crashes, and bubbles. In short, Bob Farrell has seen it all.
10 Rules
One: Markets tend to return to the mean over time.
Translation: Trends that get overextended in one direction or another return to their long-term average. Even during a strong uptrend or downtrend, prices often move back (revert) to a long-term moving average.
Two: Excess moves in one direction will lead to an excess move in the opposite direction.
Translation: Markets that overshoot on the upside will also overshoot on the downside, like a pendulum. The further it swings to one side, the further it rebounds to the other. The chart below shows the Nasdaq bubble in 1999 and the Percent Price Oscillator (52,1,1) moving above 40%. This means the Nasdaq was over 40% above its 52-week moving average and overextended. This excess led to a similar one when the Nasdaq plunged in 2000–2001, and the Percent Price Oscillator moved below -40%.
Three: There are no new eras—excesses are never permanent.
Translation: There will be a hot group of stocks every few years, but speculation fads do not last forever. In fact, over the last 100 years, we have seen speculative bubbles involving various stock groups. Autos, radio, and electricity powered the roaring 20s. The nifty-fifty powered the bull market in the early 70s. Biotechs bubble up every 10 years or so. There was the dot-com bubble in the late 90s. “This time it is different” is perhaps the most dangerous phrase in investing. As Jesse Livermore puts it:
A lesson I learned early is that there is nothing new in Wall Street. There can’t be because speculation is as old as the hills. Whatever happens in the stock market today has happened before and will happen again.
Four: Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways.
Translation: Even though a hot group will ultimately revert back to the mean, a strong trend can extend for a long time. Once this trend ends, however, the correction tends to be sharp. The chart below shows the Shanghai Composite ($SSEC) advancing from July 2005 until October 2007. This index was overbought in July 2006, early 2007 and mid-2007, but these levels did not mark a top, as the trend extended with a parabolic move.
Five: The public buys the most at the top and the least at the bottom.
Translation: The average individual investor is most bullish at market tops and most bearish at market bottoms. The survey from the American Association of Individual Investors is often cited as a barometer for investor sentiment. In theory, excessively bullish sentiment warns of a market top, while excessively bearish sentiment warns of a market bottom.
Six: Fear and greed are stronger than long-term resolve.
Translation: Don’t let emotions affect your decisions or your long-term plan. Plan your trade and trade your plan. Prepare for different scenarios so you will not be surprised by sharp adverse price movement. Sharp declines and losses can increase the fear factor and lead to panic decisions in the heat of battle.
Similarly, sharp advances and outsized gains can lead to overconfidence and deviations from the long-term plan. To paraphrase Rudyard Kipling, you will be a much better trader or investor if you can keep your head about you when all about are losing theirs. When the emotions are running high, take a breather, step back, and analyze the situation from a greater distance.
Seven: Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names.
Translation: Breadth is important. A rally on narrow breadth indicates limited participation, and the chances of failure are above average. The market cannot continue to rally with just a few large-caps (generals) leading the way. Small- and mid-caps (troops) must also be on board to give the rally credibility. A rally that lifts all boats indicates far-reaching strength and increases the chances of further gains.
Eight: Bear markets have three stages—sharp down, reflexive rebound, and a drawn-out fundamental downtrend.
Translation: Bear markets often start with a sharp and swift decline. Following this decline is an oversold bounce that retraces a portion of that decline. The decline then continues, but at a slower and more grinding pace as the fundamentals deteriorate. Dow Theory suggests that bear markets consist of three down legs with reflexive rebounds in between.
Nine: When all the experts and forecasts agree – something else is going to happen.
Translation: This rule fits with Farrell’s contrarian streak. When all analysts have a buy rating on a stock, there is only one way to go (downgrade). Excessive bullish sentiment from newsletter writers and analysts should be viewed as a warning sign. Investors should consider buying when stocks are unloved, and the news is all bad. Conversely, investors should consider selling when stocks are the talk of the town, and the news is all good. Such a contrarian investment strategy usually rewards patient investors.
Ten: Bull markets are more fun than bear markets.
Translation: Wall Street and Main Street are more in tune with bull markets than bear markets.
Closing Thoughts
Like all rules on Wall Street, Bob Farrell’s 10 rules are not intended to be considered hard and fast or set in stone. There are exceptions to every rule. Nevertheless, these rules will benefit you as a trader or investor by helping you to look beyond the latest news headlines or your gut emotions.
Being aware of sentiment can prevent traders from selling near the bottom and buying near the top, which often goes against our natural instincts. Human nature causes individual investors and traders to often feel most confident at the top of a market. Simultaneously, they often feel most pessimistic or cautious at market bottoms. Awareness of these emotions and their potential consequences is the first step towards conquering their adverse effects.
To read our investment psychology article about 11 of the most common cognitive biases affecting investors and traders in financial markets, click here.
Not a recommendation to buy or sell any security. For discussion purposes only. Current viewpoints are subject to change.
Not a recommendation to buy or sell any security. For discussion purposes only. Current viewpoints are subject to change.
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Personal Note: Reputation and Resilience
“It took us 37 years to get there, but we could lose it in 37 seconds.”
– Warren Buffett
Every year, Buffett writes a letter to his managers. My wife Susan shared it with me. He tells them, “We’ll lose money, even a lot of money; we can not afford to lose our reputation. We’ll figure out ways to make money, but we can’t lose a shred of reputation because we can’t get it back.” Click on his photo to play the short clip.
Source: Instagram
Jensen Huang, NVIDIA CEO, spoke to students at Standford University. This was fantastic!
“I wish upon you ample doses of pain and suffering.”
– Jensen Huang
Source: Instagram
Following is a quick summary of his presentation to the students:
“You deserve to have high expectations because you come from a great school. You’ve been very successful, graduating at the top of your class from one of the finest institutions in the world. Clearly, you were able to manage the challenges of tuition, academics, and competition, surrounded by similarly ambitious and talented peers. Naturally, you have very high expectations.
However, there’s a challenge that often accompanies high expectations: low resilience. Unfortunately, resilience is a crucial ingredient for success, and it’s something that’s not easily taught. I hope life presents you with challenges that foster this quality. I say this from experience—I was fortunate to grow up with parents who provided the foundation for success, but my journey included many setbacks and moments of suffering. Those experiences shaped me profoundly.
Even now, I use the phrase “pain and suffering” within my company—not with negativity, but with a sense of purpose. Challenges refine character and character—not intelligence—is what defines greatness. Greatness emerges from those who’ve faced adversity and grown from it.
So, to all of you Stanford graduates, I offer an unconventional wish: that life grants you ample doses of pain and suffering. Embrace them because, through pain and suffering, true resilience and character are forged. And that is the foundation of greatness.” – Jensen Huang
2025. Another year. Time moves too quickly.
Christmas was fantastic. I got a Saquon Barkley #26 Jersey and will wear it at the Eagles-Cowboys game this Sunday. Five of our six children are home and with us through the weekend. It is so nice having everyone home. We missed Brianna as she is adventuring through Asia on her way from Sri Lanka to Singapore to the Philippines and then on to Japan for some skiing. Her gift was Venmoed to her. Dad’s not sure how much more runway she has. Jealous… Brianna, I wish you experiences that shape you profoundly.
Hold that glass up high – I wish you and your family a happy and healthy New Year!
With kind regards,
Steve
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Stephen B. Blumenthal
Executive Chairman & CIO
CMG Capital Management Group, Inc.
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Stephen Blumenthal founded CMG Capital Management Group in 1992 and serves today as its Executive Chairman and CIO. Steve authors a free weekly e-letter entitled, “On My Radar.” Steve shares his views on macroeconomic research, valuations, portfolio construction, asset allocation and risk management.
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