Research.LeutholdGroup

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February’s cool CPI figures were a welcome step down from January’s hot readings. Positive market reaction to the news was spotty. Trends that would suggest a cold economy and hot inflation are still in the early stages but uncertainty remains high.

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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.

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.

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.

Despite volatile headlines, the German DAX index has staged a stellar double-digit rally since the start of the year—outpacing even the most “exceptional” S&P 500. In fact, over the last year or so, the DAX has now pulled ahead of the S&P 500.

The index’s income statement turned in one of its best showings of recent years. Year-over-year sales growth for S&P 500 companies landed at 5.6%, exceeding the 5.0% rate in nominal GDP and mimicking the sales growth posted earlier in the year. 

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The S&P 500’s bottom-up operating EPS continued to improve in the second month of reporting. Since the start of Q4 announcements, the EPS figure has increased 1%. The direction of the estimate, not necessary the amount, is what’s impressive. The same can’t be said for the coming two quarters, however. Bottom-up projections for Q1-25 have fallen 4% in the last two months, while Q2-25 is off 2%. Again, sharp moves higher in the EPS snail trails are exceedingly rare. With almost all of the reporting done for 2024, the S&P 500’s operating EPS of $234 equates to a healthy YOY gain of 9.5%. The expectation for full-year 2025 currently stands at +14.3%.

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Defined Outcome and Derivative Income ETFs each offer attractive features in the form of modified payout or income characteristics. However, these benefits come at a cost of limited upside, and a “buyer beware” approach should be taken to weighing their pros and cons. Sustained bull markets reveal the true impact of trading potential upside for considerable benefits in the here and now. This study attempts to quantify the opportunity costs of capped funds using 2023-24 as a particularly harsh test case.

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The latest CPI report came in a tad hotter than consensus. Policies are likely the key driver of economic outcomes, including inflation, and we should get ready for more volatility going forward.

We believe stock market leadership will transition from Growth to Value in 2025. The P/E premium commanded by Growth stocks relative to Value is high, although not (yet?) quite as extreme as at the Y2K Technology bubble peak.

When the S&P 500 made all-time highs the week of Thanksgiving and the following week, we viewed it as “risky, but not toppy.” Today, it is every bit as risky, but now looks toppy, too. There’s enough “wrong” with the picture that if the market immediately began to fall apart, the technical crowd would be able to cry, “It was obvious!”

Broad investor interest has validated the attractiveness of buffer and covered call funds. An important part of understanding these ETFs is having a solid grasp of the upside participation that is sold away. The last two years provided a perfect environment to empirically measure the give-up associated with selling calls.

There were two new group positions this month: Internet Services & Infrastructure and Hotels & Leisure. Trading Companies & Distributors was sold.

After an initial post-election surge, hopes of a small-cap Trump bump seem to be fading. Since election day through the end of January, the Equal Weighted S&P 500 (+1.9%) has essentially matched the S&P 600 (+2.1%).

Bond market reactions are consistent with the historical norm, so far, and suggest that a reversal of the current bear steepening is more likely than not.

The year 2024 will go down as one of the most hostile environments for active investors in the last 30 years. Style, size, and absolute market returns all have an impact on the relative performance of active versus passive portfolios; the fourth quarter continued a trend that has been in place for over two years.

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It depends on who you ask. Non-equity investors might think the Trump trades are playing out just like in 2016. Over the last few months, FX traders and bond investors could have followed the 2016 script and made out like bandits (Charts 1 & 2). However, at this juncture, it might be time to at least take some chips off the table—if the 2016 analog stays intact, both the U.S. dollar and interest rates are poised to change course over the next few months. Near-term knee-jerk reactions aside (stronger dollar, lower yields), the newly announced tariffs will likely impact growth more than anything else, which would make it hard to sustain a stronger dollar and higher rates. 

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• Read the latest MTI update

This study provides an initial look at 2024 factor returns, paced by a 25% gain for the S&P 500 index. Three factors topped the S&P (one by just a smidgen) while eight fell short, a ratio we will later see is typical for exuberant bull markets. Of the laggards, six trailed the S&P by more than 10% with a seventh just sneaking inside that ignominious cut point, and their shortfalls contributed to an average factor spread of -6.3% for the eleven contenders.  We also find that 2024 was an echo of an even tougher 2023 when the S&Ps 26.3% return was also driven by mega-cap growth, causing nine factors to lag the index with an average shortfall of -9.0%. Two consecutive years with similarly spectacular yet narrow S&P returns led to significant underperformance across our basket of factors and motivated us to try to understand more about this phenomenon.

December’s Core CPI figures we’re cooler than expected. Markets reversed out some of the damage caused by Friday’s hot jobs report. The market is pricing in only one or two Fed cuts in 2025, down dramatically from this fall.

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New Years Eve 2024 was a party to remember for the 4% Club (stocks with a minimum 4% weight in the S&P 500). Thanks to December’s ridiculously top-heavy performance, a record five firms toasted the new year in the VIP-only Club (Chart 1). For most of the past five years, membership had been limited to two or three companies. Before that, the Club’s March 2000 high-water mark of three firms seemed unobtainable—and, with a little hindsight, a laughable signpost of the Tech Bubble. Well, who’s laughing now?

In the theme that’s reminiscent of all but a few of the last 16 years, the optimal strategy for equity managers and asset allocators in 2024 was the same: Buy the S&P 500, and then hit the links. There is statistical support for doing exactly same thing in 2025. 

Commemorating the Y2K Tech bubble today is not necessarily premature, since December 1999 was the valuation peak of that bubble—and indeed of all U.S. stock market history. Buying the S&P 500 at the end of the last century might therefore be considered the worst-timed stock market entry ever.

One can’t blame the stock market for not hinting that 2024 was going to be a barn burner. It did. On January 2, 2024, a critical “breadth-thrust” signal was triggered and, true to historical form, SPX delivered a 20%-plus gain through the next twelve months. Notably, an impressive aspect of the breadth-thrust track record remains intact: The index has never registered a 12-month loss after any these signals.

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Momentum was the best performing factor for 2024 - and it wasn’t really close. Growth continued to perform better within large caps compared to small caps. Sentiment and growth were also positive while, no surprise, value was negative again.

Over the entire history of this study, the momentum plays of our “Dreams” and “Nightmares” have worked both ways. Like everything else, our Dreams fell short of the Cap Weighted S&P 500 in 2024. However, the spread of Dreams over the Nightmares was fairly impressive.

Overall, most patterns suggest a decent year for global equity markets. Expectations are already very high, though, and that leaves much less room for error. We strongly caution against extrapolating U.S. equities’ 2024 performance into 2025.

Our previous update reported that eight of ten factors outperformed the S&P 500, leading us to hope that maybe, just maybe, the market was broadening out from its narrow focus on mega-cap growth. Those hopes were dashed in the fourth quarter, as only two of ten factors managed to outperform the index.

The turning of the calendar is a time to reflect on the past year’s returns and analyze the relative performance of various asset classes. For 2024, no matter what equity theme is under the microscope, the yearly recap is bound to point to the very same explanation—Nvidia and mega-cap tech.

Read the latest MTI update

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