2024 has been a banner year for stocks so far. That has many investors worried.
Through the end of the third quarter, U.S. large-cap stocks as measured by the S&P 500 were up +22% (including dividends), and other previously lagging market areas—like small-caps and value stocks—have also posted strong rallies. Apart from the Energy sector, every S&P 500 sector is up at least 20% over the past 12 months.
One data point that caught my attention this week: the S&P 500 index currently trades at levels 20% higher than the Wall Street consensus for all of 2024.1
For many investors, strong equity market returns feel completely disconnected from on-the-ground economic realities. Many households continue to harbor negative feelings about the economy, mostly tied to the rapid jump in prices during the 2022-2023 inflation event. Throw in two ongoing wars, destructive storms, and a contentious election season in the U.S., and many wonder where the optimism comes from at all. Although jobs have been plentiful and real wages have been rising more recently, the prevailing sentiment is that stocks’ surge this year has been too far, too fast.
Consumer Sentiment Has Improved, But Still Remains at Post-2008 Crisis Levels
I sense that a ‘fear of heights’ mentality is taking hold as the market continues to rise, with investors anticipating that ‘what goes up must come down.’ This is a fine assumption, given that bear markets always follow bull markets. Where it goes astray, however, is in assuming that bear markets are caused by strong bull market rallies, and/or immediately follow them. History doesn’t support this line of thinking.
For one, stock market returns—whether it’s the S&P 500 index, the Russell 2000 index, or some other category—are not serially correlated. Put another way, how U.S. stocks perform one year has no bearing on how they’ll perform the next year. Performance affects valuations—which can be useful in forecasting forward returns—but just because stocks rise +40% or fall -20% in a given year does not tell us anything about what to expect for the next 12 months. To ascertain those types of return probabilities, we turn to fundamental analysis—not to historical returns.
Some have pointed out that the S&P 500’s over +20% year-to-date gain should raise eyebrows not only for its magnitude, but also because it so closely follows 2023’s +26% gain. These returns are roughly double the S&P 500’s average annualized return of 10.26% from 1957 through the end of last year.
This is true. But what’s missing from this line of thinking is that the S&P 500’s long-run annualized returns include bear markets. If we look at just bull markets, the average annualized return is closer to 23% (going back to 1932), which makes 2023 and 2024 look more like average years than outliers.
If we could make the argument that strong equity market returns were making investors optimistic to the point of being euphoric, then I believe we’d have a cause for concern. But as I detailed above, I believe investors still largely feel uneasy about the current economic and geopolitical setup, particularly in an election year. The better case, in my view, is that stocks are continuing to climb the wall of worry as economic fundamentals strengthen—not that euphoric sentiment is pushing investors further out on the risk curve than they should be.
Bottom Line for Investors
Bull markets do not end simply because stocks have risen briskly for two years in a row. There is no mean for stocks to revert to, and corporate earnings do not grow or contract on some predetermined schedule or timeline. The S&P 500’s return in one year does not shed light on its potential return the next. There is no doubt that a bear market will follow this bull market, and it may very well follow a strong year of returns. But it won’t be because of that strong year—it will be because a global economic shock or cyclical recession dents global GDP by trillions of dollars. That’s not something we currently see happening in the next year.
Disclosure
1 NY Times. October 11, 2024. https://www.nytimes.com/2024/10/11/business/stocks-investing-bull-market.html
2 Fred Economic Data. September 27, 2024. https://fred.stlouisfed.org/series/UMCSENT#
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