Quarterly Review & Market Outlook – 4th Quarter 2024
The best way to predict the future is to invent it.
– Alan Kay
Investors are in wait and see mode after a strong run for global markets. Absolute returns for most asset classes have been solid the last two years. Credit market performance was exceptional. Relative returns across investment styles have been tied to the weighting of technology. Large US companies have therefore led the way as the S&P 500 Index rose 26% in 2023 and 25% in 2024.
We look back two years because the starting point matters. Investors were then saying good riddance to a volatile 2022 when stocks and bonds fell double digits. A Bloomberg article pinned the odds of recession at 100%. The Fed published economic projections suggesting that getting inflation back to normal would mean a million job losses. The earnings outlook was muted. Pessimism was the norm.
Optimism abounds today. The economy is growing along its trend, driven by rising productivity and a public-private investment boom. The labor market is healthy, as are household and corporate balance sheets. Fed credibility is high. Earnings for US companies are expected to grow 10% each of the next two years. These S&P 500 Index trades at a healthy multiple because investors are paying a premium to access the asymmetrical potential payoff from artificial intelligence (AI).
We are still optimistic, just a bit more cautious as our view has steadily moved along the spectrum from contrarian to consensus. But there is a difference between cautious and bearish. It is impossible to ignore the dynamism of the technology sector. We see charts going around comparing the current market to historical eras when indexes were dominated by banks or turbine manufacturers, but the proper application of history requires humility alongside skepticism.
The large technology giants operate at a scale that was impossible before now. Microsoft and Google are built atop the internet, with near zero marginal cost and a global marketplace. There will be limits to scale eventually—natural or regulatory—but the wave of innovation and investment unlocked by Large Language Models (LLMs) has introduced the possibility that those limits are still far away.
These are still the early days for AI applications. New tools are being introduced daily to supercharge workers. Headlines mostly focus on general models like ChatGPT, but domain-specific applications will soon transform entire industries. The economy overall should benefit, with the most value going to innovators working on ideas right now, all over the world, but mostly it seems in Silicon Valley.
There is no guarantee the winners of the next decade will mirror the last. AI is advancing quickly, but the marginal cost is a long way from zero. Microsoft plans to invest $80 billion globally in data centers this year. The companies that physically built the internet in the 1990s faded to oblivion as software devoured the profits. The AI business model has never existed either. No one knows if the economics will look more like internet search or turbine manufacturing.
Now is the time for investors to decide how long-term they really are. There are attractive cash flows available in many areas that pair well with the high risk, high reward technology sector. The decision to own more or less of each depends on the individual and the degree to which one is willing and able to weather the inevitable storms that blow through markets.
Our success is ultimately judged on whether you achieve your financial plan. Benchmarks matter, but only in pursuit of financial security and peace of mind. We value your trust, and we look forward to navigating these uncharted waters together.
Written by Waverly Chief Investment Officers
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| Clay McDaniel, CFA
Chief Investment Officer Private Markets |
John B. Cox, CFA, CAIA
Chief Investment Officer Public Markets |
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