It's the Magnificent 7, Not the 'Magic' 7, So Don't Expect Another Hat Trick
Investors should not count on a third-straight year of outsized returns in 2025; and here are my two big concerns for the market.
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The S&P 500 rose some 23% in 2024. This was the second year in a row that the index provided a return of over 20%. This is something that hasn’t happened since 1997 and 1998. Longtime investors may recall that the S&P 500 nearly made it a hat trick back then, returning just less than 20% for the year in 1999. Unfortunately, that was followed by the internet bust in early 2000. Before the market found its bottom in the summer of 2002, the S&P 500 fell more than 40% while the Nasdaq was taken out to the back of the shed and beaten like a rented mule. The tech-heavy index would implode by 83% from peak to trough.
My portfolio had a more modest return than the S&P 500 in 2024, delivering approximately 17% for the year. Given most of my holdings were in covered call positions with a good chunk in short-term Treasuries throughout the year, I am more than fine with that performance. I took a lot less risk within a market I still consider overbought. I continue to have two major concerns around the overall market. The first is valuation and by several metrics the equity market is as generously valued as it has been in my lifetime, and that includes the internet boom and bust.
Almost all the earnings growth from the S&P 500 last year came from the Magnificent Seven tech stars. Most of the gains in the market in 2024 came more from multiple expansion than earnings growth. Take Apple AAPL, whose fiscal year for 2024 ended on Sept. 30. The company delivered flat earnings and 2% revenue growth for fiscal 2024. The stock still rose by 30% in 2024 and begins 2025 trading for 40-times those profits. That is way too rich for my blood.
My other major concern for the market is the deteriorating debt situation across many parts of the economy. This starts with the federal government, which begins 2025 with over $36 trillion in debt. In addition, the average interest rate on that debt piled has more than doubled over the past three years to 3.4%. This means just the interest to service existing debt will come in north of $1 trillion in 2025. Delinquency rates across the commercial real estate loan space continue to move higher as well. The delinquency rate for commercial mortgage-backed securities against office properties in December crossed over 11%, according to a recent report from Trepp. That exceeds the wort levels of the Great Financial Crisis and its aftermath, to put in perspective. The good news is this exposure is spread across regional banks, pension funds, hedge funds and other lenders. The big banks’ exposure to this rapidly decaying part of the credit ecosystem is manageable.
Then we have the consumer. Housing affordability is near record lows, which should keep the housing market moribund for the third-straight year. The credit situation for lower and even middle-income consumers is getting worse, as well. The U.S. credit card serious delinquency rates for subprime borrowers is north of 20%. This is the highest level since 2010.
Given valuations and debt levels, I don’t think the markets in 2025 will experience a continuing melt up like in 1999. Investors will be very fortunate with gains in the mid-single digit range in the coming year and should position accordingly.
At the time of publication, Jensen had no position in any security mentioned.
