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The Up/Down ratio reads 1.41. This final figure for 2024 marks four consecutive quarters of improvement. Will the broadening earnings-growth story continue in 2025? Soft look-backs and momentum will have to overcome the renewed possibility of an economic recession.

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Extended bull markets are the primary attraction of equity investing and play an integral role in generating long-term returns.  However, investors must take heed when psychological excesses turn a garden variety bull market into mania-induced price chasing.  Instead of reaping the customary gains offered up by a typical bull, the risk and reward tradeoffs become exponentially larger when exuberance overpowers prudence.  Recognizing the difference between a bull market and a bubble is critical for building a respectable long-term track record.   There are subjective attributes common to most manic equity markets, and although these signposts are not mechanical or quantitative, taken together they tell a coherent story.

With yesterday commemorating the 25th anniversary of the S&P 500 Y2K peak, it’s worth evaluating the long-term results of the unlucky purchases of U.S. equities occurring at that time. Of course, it’s doubtful that many investors decided to dump their money-market funds and go “all in” on stocks that day. Instead, think of this analysis as a review of how one’s dutiful, monthly 401(k) contribution for March 2000 has likely performed over the subsequent 25 years.

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This essay takes a broader view of Manias, Bubbles, Panics, and Crashes by expanding on these terms, considering the benefits of studying stock market bubbles, and looking for commonalities that mark each phase of a euphoric price cycle.  The most practical reason to study bubbles and crashes is the simple fact that they appear far more often than one might expect. Rational investors may be inclined to dismiss the periodic appearance of bubble conditions as just so much noise and frivolity, leaving us to focus on real world issues like the economy, profits, and expected returns. However, we believe the impact of manias and crashes on investment performance over an entire career is significant to the point of being decisive, and that is the most compelling reason to study the history of financial manias.

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Select Industries was down 4.1% in February, lagging the S&P 500, but in-line with mid and small cap benchmarks.  Homebuilding continued to struggle with buyer affordability and shrinking margins, while growth-oriented groups like Interactive Media and Internet Services sold off amid the rotation out of growth.  Holdings in defensive industries (Health Care, Telecom, Insurance) worked to offset weakness throughout the rest of the portfolio.  The strategy is up 1.9% year-to-date.

Read this week's Major Trend. 

The median normalized P/E ratio for the S&P SmallCap 600 fell to 21.0x in February, the bottom quintile of all monthly observations since 1994. Historically, a normalized P/E multiple near the current level has been associated with a five-year-forward annualized return for small caps in the double digits.

Since the onset of the current bull market over two years ago, the S&P 500 Normalized P/E multiple has resided in its top historical quintile. That is an incredible feat—but one that has borrowed from the future.

A sudden loss in investor confidence, like the recent plummet in the AAII Bull-Bear Spread, can occasionally become a self-fulfilling prophesy—and the current backdrop raises the odds that might be the case. Furthermore, consumers’ assessment of their Present Situation (Conference Board Survey) is now lower than at the October-2022 bear market bottom.

Only time will tell if the S&P 500’s February 19th high will turn out to be the ultimate top for this bull market. One dynamic for which we do have high conviction is that the tide has turned away from the large-cap growth crowd that has trounced all challengers since the market lows in October 2022.

A number of S&P 500 valuation measures are challenging the peak levels seen just before the Y2K Tech Bubble blow-up. Ironically, despite the stock market being vastly larger today relative to the economy (197% of GDP vs. 137% in February 2000), present day consumers are not nearly as euphoric as they were 25 years ago.

For months, the euphemism to describe the weakening labor market has been “normalization.” Our preferred terminology has been “pre-recessionary,” and the numbers continue to trend in that direction.

Federal receipts are projected to move higher in the months ahead, as capital gains taxes are collected. Lately, though, growth in tax receipts has fallen short of that forecast. After 16 years of a mostly rising stock market, we wonder if investors have been trained not to sell.

Flip-flopping about tariffs has damaged confidence and at a time when the economic expansion already looks fragile. Back in 2017 and 2018, Trump Tariffs 1.0 occurred with an economy much better positioned to absorb the tariffs themselves, as well as the confusion surrounding them.

Our composite of S&P Cyclical sectors topped more than three months ago. However, the action in this index looks even more ominous when compared to recession-resistant sectors like Consumer Staples, Health Care, and Utilities. 

Given the prominence of the wealth effect in recent years, it’s hard to fathom the economy not succumbing to a declining stock market. But, keep the Y2K example in mind if the economy doesn’t appear to justify a falling stock market.

Early this month we trimmed net equity exposure to 50% across tactical allocation strategies. Breadth, leadership, and momentum into the SPX high on February 19th all showed divergences that could have been pulled from an “analyst’s handbook” of bull market tops.