Consider the field of health and medicine. You can have a biology degree, a medical degree from a top school, and read scholarly journals to stay abreast of the latest findings. But if you have a poor diet, and lack sleep and exercise, you will not achieve a good health outcome. None of that intelligence matters until the proper behaviors are in place. Investing is similar. You can have extensive knowledge of markets, math, and data. But unless you can master your sense of fear and greed, and handle periods of uncertainty, you will have disappointing results.
The last few months have certainly tested investors’ ability to manage their behavior. Pre-election uncertainty, the optimism of new market highs after the election, and apprehension over the new administration’s policies since the Inauguration have given ample opportunity for investors to react with emotion rather than discipline. It is times like this when our objective process is particularly useful.
Today the objective indicators show a mixed message on the market. It is consistent with our commentary from January that “evidence suggests 2025 will see more volatility and lower returns than the prior two years”. The theme of the year has been “three steps forward, two steps back”, and that is likely to continue. Small cap stocks have declined this year, a sign of diminishing risk appetite among investors. Analysts have recently cut estimates for Q1 2025 corporate earnings at an above-average pace. Despite February’s market selloff, signs of selling exhaustion are absent, implying that the recent choppiness could continue into March. Markets need more clarity on policy out of Washington before they can rally sustainably. Policy uncertainty will not last forever, but it is with us for now.
But the weight of the evidence does not suggest that a large decline is imminent either. There are some positive signs within the market as well. The financial sector, key for gauging the health of the economy, is the 2nd best performing sector for the year through February. Several indicators suggest that the majority of components within the S&P 500 are holding up better than the index itself, given the weakness in a few large companies which dominate the index. Q4 2024 corporate earnings growth came in at 17.8% according to Factset – the fastest growth in 3 years. And investors have been quick to raise cash (sell stocks) and turn fearful. Extreme levels of investor pessimism, like we have recently seen in one widely followed survey, have historically been followed by strong market returns.
In summary, the market is undergoing a choppy period, which is not unexpected given the state of the indicators at the beginning of the year. Times like this can test one’s emotions, but recent market behavior is not unusual. The big picture evidence suggests the market and economic backdrops are healthy. We urge investors to look past the noise of the day, expect volatility and modest returns, and to stick with their plans.
