2024 Q4 Newsletter
This year, I had the good fortune of spending my holidays with wonderful friends and family, often eating too much, and chatting deeper into the night than life’s usual hustle and bustle permit. These people are familiar with my inclinations and interests, so the topic of markets came up often. Questions pertaining to market direction and favoured sectors were served up with a side of panettone and eggnog. The responses I offered were cocktails constructed from the countless reports and presentations I’ve been fortunate enough to observe since the dramatic election results in November. I describe the results of the election as dramatic because both Trump’s margin of victory and the Republican victory over both the House and the Senate have built a strength of mandate different from many past presidencies. This super mandate has created an environment of uncertainty and a decided lack of consensus among analysts.
Recent opinions presented from strategists, economists, and technicians with respect to market direction, sector and geographic positioning are varied and often at odds. In a strange way, the degree of consensus embodied by the results from November’s election have created an environment of dissenting opinions, which are likely to produce disparate results. Is Trump’s tough talk on tariffs all bluster and positioning as some suggest, or will he follow through and test an aggressive America-first agenda? Will defence spending accelerate, as is usually the case under Republican-led budgeting or will existing relationships and contracts become strained as Elon Musk’s Doge endeavour seeks to pare back government spending? Musk has already spoken out in opposition of the world’s largest military spending program, calling the F-35 obsolete and labeling those building them “idiots.”
Over the next four-year period, we are likely to see an accelerated pace of change. In the past, strategists have emphasized the point that presidencies are most often only able to implement one or, at most, two major policy changes during a term. I recently attended a presentation where a U.S. political strategist argued that this time, it’s different. He highlighted two important features that may substantially increase this president’s ability to affect change. The Republicans control both houses and the executive branch and Trump controls the Republicans. The strategist asserted that Trump had greater-than-normal control over his own party because his popular vote exceeded the mark of all other elected Republicans and thus, his mandate and authority become undeniable. A Republican member of the house or senator who votes against a Trump bill, in favour of their own constituency, may find themselves running against a Trump-endorsed Republican candidate at the next election. This concentration of control increases the chances for change and change inevitably produces winners and losers. **The division of outcomes could be at sector or geographic level, but may more likely be at the company level, as the individual circumstances and fortunes of each firm diverge from those of their industry or region.
During an eggnog conversation on markets, I had with a dear friend, I proffered that during this period of uncertainty, we should be favouring companies which display the qualities of high return on equity and trade at reasonable price to earnings multiples (P/E). His response was, “Isn’t that what we should do at all times?” I agreed but couldn’t shake the feeling that our discussion had failed to address some important detail or factor.
It came to me soon after. My statement wasn’t true last year. High P/E companies produced a disproportionate amount of last year’s returns, with the Magnificent Seven (Tesla, Nvidia, Amazon, Apple, Microsoft, Meta, Google) accounting for the majority of the S&P’s total gains. The S&P returned 23.3% in 2024. The S&P without the Magnificent Seven (Mag 7) returned only 6.3%. This is the second consecutive year exhibiting an almost identical disparity in performance between the two groups. All the Mag 7 stocks trade at P/E multiples greater than the S&P 500 index as a whole. The average multiple of the Seven is twice that of the index and the highest multiple in the group is just shy of five times the multiple of the S&P 500.
My assertion that the characteristics of high return on equity (ROE) combined with low price to earnings (P/E) multiples produce attractive investment opportunities, can be proven false when evaluating individual stocks and specific periods of time. However, as a principle generally applied, historic data supports this assertion. What does this all mean? Index investors beware. The Mag 7 now totals a full third of the S&P 500’s overall market capitalization. A regression towards the mean in terms of P/E multiple would have devastating effects on indexed market performance.
Supporting these high multiples (P/E) is the fact that the Mag 7 is set to report 36% growth in earnings year over year into the end of 2024. This contrasts with the 3% growth in earnings expected for the rest of the S&P 500 companies over the same period. This earnings growth is underpinned by capital expenditures (CAPEX) or in simpler terms, spending on the business. Again, the Mag 7 has exceeded the rest of the market, dramatically outspending the S&P 493 during 2024. This disparity in spending is forecast to decline into 2025, as is the disparity in earnings growth between the Mag 7 and the S&P 493. This normalization has been forecast and subsequently delayed by three quarters already. If the normalization involves weakening earnings growth for constituents of the Mag 7, their concentration within the index will make index investing problematic and stock picking will become of paramount importance.
The other major market force at play is the tightrope walking the U.S. market is currently undertaking. The rope is stretching thinner, the longer the economy stays at full employment. Off to one side lies the pit of renewed inflation and on the other side, the void of recession. The U.S. economy has only managed to stay on the rope for a maximum of 51 weeks since WWII. The current count is 43 weeks. Re-acceleration of inflation, spurred on by animal spirits, tax cuts, deregulation and pro-business administrations, killed the 1969/1999 economies. Deceleration and recession caused by increased interest rates finally choked off growth, spurred lay-offs and killed the 1990/2007 economies.
Now that we’ve thoroughly covered the dog that wags the tail, let’s move on to Canada. Our tail risks have become increasingly worrisome with the events transpiring since the New Year. Trump’s threats to wage an economic attack on Canada and deprive us of sovereignty may just be hyperbole but the threat of tariffs is real. I believe our heavily indebted consumers and public sector may be ripe for a credit cycle, given the slightest of economic shocks. It is for this reason that we continue to favor U.S. equities and avoid Canadian lenders.
Where does all of this leave us? The answer, familiar territory. We continue to believe that the four most expensive words in the English language are, “This time it's different.” We will continue to invest with a long-term vision. We will continue to focus on high-quality companies trading at attractive valuations. We will continue to diversify to protect your portfolios against event-driven forces.
Recent opinions presented from strategists, economists, and technicians with respect to market direction, sector and geographic positioning are varied and often at odds. In a strange way, the degree of consensus embodied by the results from November’s election have created an environment of dissenting opinions, which are likely to produce disparate results. Is Trump’s tough talk on tariffs all bluster and positioning as some suggest, or will he follow through and test an aggressive America-first agenda? Will defence spending accelerate, as is usually the case under Republican-led budgeting or will existing relationships and contracts become strained as Elon Musk’s Doge endeavour seeks to pare back government spending? Musk has already spoken out in opposition of the world’s largest military spending program, calling the F-35 obsolete and labeling those building them “idiots.”
Over the next four-year period, we are likely to see an accelerated pace of change. In the past, strategists have emphasized the point that presidencies are most often only able to implement one or, at most, two major policy changes during a term. I recently attended a presentation where a U.S. political strategist argued that this time, it’s different. He highlighted two important features that may substantially increase this president’s ability to affect change. The Republicans control both houses and the executive branch and Trump controls the Republicans. The strategist asserted that Trump had greater-than-normal control over his own party because his popular vote exceeded the mark of all other elected Republicans and thus, his mandate and authority become undeniable. A Republican member of the house or senator who votes against a Trump bill, in favour of their own constituency, may find themselves running against a Trump-endorsed Republican candidate at the next election. This concentration of control increases the chances for change and change inevitably produces winners and losers. **The division of outcomes could be at sector or geographic level, but may more likely be at the company level, as the individual circumstances and fortunes of each firm diverge from those of their industry or region.
During an eggnog conversation on markets, I had with a dear friend, I proffered that during this period of uncertainty, we should be favouring companies which display the qualities of high return on equity and trade at reasonable price to earnings multiples (P/E). His response was, “Isn’t that what we should do at all times?” I agreed but couldn’t shake the feeling that our discussion had failed to address some important detail or factor.
It came to me soon after. My statement wasn’t true last year. High P/E companies produced a disproportionate amount of last year’s returns, with the Magnificent Seven (Tesla, Nvidia, Amazon, Apple, Microsoft, Meta, Google) accounting for the majority of the S&P’s total gains. The S&P returned 23.3% in 2024. The S&P without the Magnificent Seven (Mag 7) returned only 6.3%. This is the second consecutive year exhibiting an almost identical disparity in performance between the two groups. All the Mag 7 stocks trade at P/E multiples greater than the S&P 500 index as a whole. The average multiple of the Seven is twice that of the index and the highest multiple in the group is just shy of five times the multiple of the S&P 500.
My assertion that the characteristics of high return on equity (ROE) combined with low price to earnings (P/E) multiples produce attractive investment opportunities, can be proven false when evaluating individual stocks and specific periods of time. However, as a principle generally applied, historic data supports this assertion. What does this all mean? Index investors beware. The Mag 7 now totals a full third of the S&P 500’s overall market capitalization. A regression towards the mean in terms of P/E multiple would have devastating effects on indexed market performance.
Supporting these high multiples (P/E) is the fact that the Mag 7 is set to report 36% growth in earnings year over year into the end of 2024. This contrasts with the 3% growth in earnings expected for the rest of the S&P 500 companies over the same period. This earnings growth is underpinned by capital expenditures (CAPEX) or in simpler terms, spending on the business. Again, the Mag 7 has exceeded the rest of the market, dramatically outspending the S&P 493 during 2024. This disparity in spending is forecast to decline into 2025, as is the disparity in earnings growth between the Mag 7 and the S&P 493. This normalization has been forecast and subsequently delayed by three quarters already. If the normalization involves weakening earnings growth for constituents of the Mag 7, their concentration within the index will make index investing problematic and stock picking will become of paramount importance.
The other major market force at play is the tightrope walking the U.S. market is currently undertaking. The rope is stretching thinner, the longer the economy stays at full employment. Off to one side lies the pit of renewed inflation and on the other side, the void of recession. The U.S. economy has only managed to stay on the rope for a maximum of 51 weeks since WWII. The current count is 43 weeks. Re-acceleration of inflation, spurred on by animal spirits, tax cuts, deregulation and pro-business administrations, killed the 1969/1999 economies. Deceleration and recession caused by increased interest rates finally choked off growth, spurred lay-offs and killed the 1990/2007 economies.
Now that we’ve thoroughly covered the dog that wags the tail, let’s move on to Canada. Our tail risks have become increasingly worrisome with the events transpiring since the New Year. Trump’s threats to wage an economic attack on Canada and deprive us of sovereignty may just be hyperbole but the threat of tariffs is real. I believe our heavily indebted consumers and public sector may be ripe for a credit cycle, given the slightest of economic shocks. It is for this reason that we continue to favor U.S. equities and avoid Canadian lenders.
Where does all of this leave us? The answer, familiar territory. We continue to believe that the four most expensive words in the English language are, “This time it's different.” We will continue to invest with a long-term vision. We will continue to focus on high-quality companies trading at attractive valuations. We will continue to diversify to protect your portfolios against event-driven forces.
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