Have the Clouds of Uncertainty Lifted?

Regardless of who you voted for, US voters have recently elected a new President.  But what does that mean for our country’s economy and your investments? What should we be considering as we move into the new year with the new administration?

In the long term, election results tend to have less impact on the overall performance of the stock market and economy than many believe. While election years often bring volatility, especially in the short term, the long-term trajectory of the economy is driven by fundamental factors such as technological advancements, consumer behavior, and global trade dynamics, rather than the outcome of any particular election. Historically, markets have demonstrated a tendency to recover quickly from election-related turbulence, with no clear correlation between election results and long-term market performance. 

Economic cycles, driven by factors like inflation, interest rates, and corporate earnings, play a much larger role in shaping the market over time. Furthermore, the power of a single administration is limited by legislative and economic realities, meaning that drastic policy shifts are often tempered by legislative outcomes or unintended consequences. Ultimately, while elections can cause short-term uncertainty, long-term investors tend to benefit from staying the course, focusing on fundamentals, and their own unique financial plans. Over time, these factors have a more lasting impact than any single election outcome. Thus, the results of elections, while important in the short term, do not tend to matter as much in the broader, long-term economic context.

Presidents often face significant challenges in implementing their agendas within a single four-year term. While campaign promises may generate expectations, the reality of governance is far more complex. Upon taking office, presidents must navigate the legislative process, address unforeseen global events, and manage domestic crises—factors that can delay or even derail policy initiatives.

Moreover, the first year of a presidency is often consumed with the transition process, establishing priorities, and setting up necessary administrative frameworks. In the latter part of the term, this president may also face the pressures of the "lame-duck" period, when their influence begins to wane.

In short, the complexities of governance, political considerations, and unpredictable events mean that a president's ability to fully carry out their agenda within four years is often limited. Due to the numerous uncertainties of what will and will not get accomplished during his term, our plan is to invest based off a few thematic assumptions we have for the incoming president and the economic backdrop he enters the Oval Office with.

So, what does the economic environment that the newly elected president enters office into look like right now?  The financial markets are currently experiencing a period of heightened uncertainty, but mostly extraordinary optimism, with equity prices reaching all-time highs. A few fundamental market valuations models can be looked for clues as to what may come next. The reason for looking at long-term valuation metrics is that they have been reliable indicators of market health and future returns. Here we’ll review the recent readings for the Buffett Indicator, look at historical Price-to-Earnings (P/E) ratios, and the Cyclically Adjusted Price-to-Earnings (CAPE) ratio, also known as the Schiller Index. When viewed together, these indicators present a counter argument to the daily rising of the markets, and may indicate that the market may be overvalued, even when potential changes the new administration may implement are taking into consideration.

The Buffett Indicator: 

Named after famed investor Warren Buffett, the Buffett Indicator measures the total market capitalization of all publicly traded U.S. stocks as a percentage of GDP. Buffett himself has called this ratio the "best single measure" of market valuation, as it compares the overall market size relative to the size of the economy. 

Historically, a Buffett Indicator value of 75% to 90% has been considered indicative of a fairly valued market, with a ratio above 100% signaling overvaluation and a ratio below 50% pointing to undervaluation. As of late 2024, the Buffett Indicator was hovering around 180%, which is significantly above its historical average. This level suggests that the stock market is potentially overvalued relative to the economy’s output. 

It is crucial to note that this metric does not measure whether the market will correct in the short term but rather provides a long-term perspective. A market that is overvalued based on the Buffett Indicator could remain overvalued for extended periods, as we have seen during past periods of market exuberance. However, it’s equally important to recognize that extreme levels such as 180% have historically preceded major market corrections, making this an important warning signal for investors.

Historical P/E Ratios: 

The Price-to-Earnings (P/E) ratio is one of the most widely used metrics for evaluating stock market valuation. This ratio measures the price of a stock relative to its earnings, providing insight into how expensive a stock or market is relative to the profits it generates. 

Historically, the average P/E ratio for the S&P 500 has hovered around 16-17. However, recent data shows that the P/E ratio for the S&P 500 has surged well beyond this historical average, reaching levels above 25. A P/E ratio this high suggests that investors are paying a premium for earnings, which may not be sustainable in the long term. 

That said, the high P/E ratio could be justified if earnings growth is realized due to the changes implemented by the new administration and remain strong in the coming years.  It is important to monitor these changes to address concerns that future growth may not live up to investor expectations. In this context, the elevated P/E ratio remains a key indicator as to whether stock prices are becoming disconnected from their underlying earnings power. 

The CAPE Schiller Index: A Long-Term Perspective

Another valuable tool for assessing market valuation is the Cyclically Adjusted Price-to-Earnings (CAPE) ratio, also known as the Shiller P/E. This metric, developed by Nobel laureate Robert Shiller, adjusts the traditional P/E ratio by using a 10-year average of earnings to account for short-term fluctuations in the business cycle. By smoothing out the impact of economic booms and busts, the CAPE ratio provides a clearer picture of the market's valuation relative to long-term trends.

Like the P/E ratio, the CAPE ratio has been elevated in recent years. As of November 1, 2024, the CAPE ratio was at 37+, well above its historical median of around 16. This suggests that the market is also overvalued on a long-term basis. The CAPE ratio can also be a predictive tool for future long-term returns. While the market can remain overvalued for extended periods, historically, high CAPE levels have been followed by years of below-average stock returns. Investors who enter the market at such elevated levels may face lower overall returns, as the market would need to correct or grow more slowly to return to a more reasonable valuation.

A confluence of warning signals. A market near all-time highs. What should we focus on?

Well, all this leaves us in a difficult place in markets.  Do the themes of less regulation, reshoring industries to the US, lower corporate tax structure, a tamping down of geopolitical rancor and a seemingly more pro-business administration offset the valuation concerns, potential trade disputes, and everything on the opposite side of that coin?  Thankfully, that is one of the reasons you have entrusted us to manage your assets.  We will continue to monitor markets, and you can monitor our progress against your plans.

Which leads of course to the focus for you, our clients and friends.  You probably knew the answer, it’s always the plan! What does a return mean if not tied to a goal?  Why work, save, and invest in risk assets at all if it doesn’t provide something that will meaningfully impact our lives?  Financial planning is the key to long-term success, far more than focusing on the short-term performance of the markets. While market fluctuations can be exciting, they are really over time just a silent partner helping us attain our plans’ goals. Emotionality around daily market movements can lead to unnecessary stress and poor decision-making. The true path to financial peace is centered around setting clear, long-term goals—such as securing you or your family’s future, funding travel, and enjoying activities and the relationships in our lives that bring joy and fulfillment.

When you prioritize long-term financial planning, you create a solid foundation that allows you to weather market volatility with confidence. By focusing on consistent savings, wise investments, and budgeting for life’s major milestones, you can work towards the life you want to live, without being consumed by short-term news or events.

I recently read that a SHOCKINGLY high 89% of Americans don’t feel wealthy.  I found that profoundly sad, personally. With a strategy in place, you should remain focused on what truly matters. By emphasizing on long-term planning, and attaining your goals, I’m not sure why that percentage is so high.  I like to think most of our clients have set themselves up for financial freedom and security, that enables them to enjoy life’s most meaningful experiences without constantly worrying about money.  Which as our clients know, is our number one goal at the firm.

Thank you for partnering with us this past year, and wishing all of you a prosperous, happy 2025!