The US economy has had two extraordinary consecutive years of stock market gains.  What happened to the recession analysts and major media pundits warned investors in 2022?   Although many sectors and indices did not match up to the performance of the S&P 500 and NASDAQ, they still had respectable returns for these past two years.

Below is a summary of the major index returns for 2024 and the past two years:

Admittedly, earning 10% to 14% per year since 2023 in the lower-performing indices is not horrible in comparison to long-term average returns.  However, focusing on S&P 500 and NASDAQ would have increased investor returns by 100% to 250%. 

For the past two years, we have focused our portfolios on the large-cap and technology sectors and will discuss later how we decided on this strategy.  We have not directly held international or emerging markets equities for more than six years due to the underperformance of the international markets. 

Our portfolios have been 100% US-focused and will remain so until market conditions improve abroad.  We also underweighted mid-cap and removed entirely small cap late last year.  Any allocation to small-cap and international would have significantly diminished all our portfolio returns and more importantly missed one of the strongest back-to-back rallies of the S&P 500 and NASDAQ since 1997.

However, favorable US stock market conditions have not been for just the past two years for the large-cap and technology sectors.  For those investors allocated in these two sectors, the past 10 years have been extraordinary.  

For the past 10 years starting January 1, 2015, the S&P 500 has outperformed the S&P 400, S&P 600, and MSCI Ex US by 50%, 77%, and 184%, respectively.  However, NASDAQ has an even better record that resembles the go-go years of the 1990s.  The NASDAQ index outperformed the S&P 500, S&P 400, S&P 600, and MSCI Ex US by 64%, 156%, and 190%, and a whopping better return by 366% than the MSCI Ex US during these past 10 years. 

Our five model portfolios have not been negatively impacted by underperforming sectors as a result of the reduced allocation to the underperforming sectors.

For reference, our five model portfolios and their global target allocations are:

Our investment strategy for our model portfolios considers momentum confirmed by technical and fundamental analysis.  What this means is that we hold stocks or sectors with positive momentum supported by positive technical analysis.  When a position trend turns negative also confirmed by supporting technical analysis we will trim the position in the model portfolio.  If the momentum of the position continues to decline, we will eventually remove it entirely from the portfolio until a positive trend resumes. 

A good example of this process was demonstrated in 2022.  The Biden administration had flooded the US economy with trillions of government subsidies just as supplies of goods were quickly diminishing due to distribution challenges.  In addition, labor costs were soaring as employers competed for new hires as many qualified people stayed home due to enhanced unemployment benefits. Compounding the labor challenges, state and federal administrations passed laws to schedule minimum wage increases by more than 100%. 

As a result, inflation as reported by the Consumer Price Index (CPI) climbed to levels not seen since 1979 as too much money was chasing after too few people and goods.  In March 2022, Jerome Powell, Federal Reserve Chairman, announced the decision by the Federal Open Market Committee (FOMC) to begin raising the discount interest rate to slow inflation.

The major indices had already started to decline in January of 2022 and by March the negative momentum had accelerated.   NASDAQ, the best-performing index for the previous two years rising 74% during 2020 and 2021, was the worst-performing index in 2022.  Below are the returns of the major indices in 2022:

We noted that history indicates that when the Federal Reserve raises rates institutional bond prices fall and investors sell stocks.  This was true in 2022 with institutional investors stampeding to the exit doors selling stocks and bonds.  The bond and US Treasury market plummeted in value driving financial institutions into bankruptcy with Silicon Valley Bank a poster child of the devastation.

As the negative momentum in the stock and bond markets developed, we began trimming growth equities and bond funds that included NASDAQ-based index ETF (XLK) and SPDR Health Care Select ETF (XLV) and all holdings of iShares Core US Aggregate Bond ETF (AGG).  The sale proceeds stayed in the money fund account.  As the downtrend continued in 2022, the cash position increased to over 12% by March 2022 in our Balance, Growth & Income, and Growth portfolios to minimize account declines.  By mid-year, the cash position had increased to over 17% in these portfolios.

The negative momentum of the major indices bottomed out in mid-October and resumed its pre-2022 positive trend that has continued to this day.  We began rebalancing the model portfolios in late August, 45 days ahead of the eventual market bottom, which included adding Nvidia (NVDA) to the Growth & Income, and Growth portfolios along with XLK.  Since the October 2022 bottom, the major indices and our portfolios have rallied significantly.

What Does This Mean to Me?

The only thing constant with the economy and stock market is change.  However, trends have a history that can be usually traced to prior events that prompt positive or negative trends.  Just as a boulder thrown into a pond develops waves, the larger the boulder the larger and longer the waves.  Major economic events like the Federal Reserve raising the discount rate 13 times in 2022 – 2023 or the Biden Administration flooding trillions into the economy will create economic waves.  Shutting down entire countries in 2020 will create tsunami-sized economic waves that will impact economies for years.  

Our job is to navigate through these economic times attempting to protect our client’s account values during negative trends and capitalize on gains during positive trends.  We are not always correct.  After more than 27 years now managing several hundreds of millions in client accounts, we continue to learn through each cycle. 

Let us know if you have any questions about your account or if you would like to schedule a time to discuss your financial planning and investment accounts.  We welcome the opportunity to work with you and your family to pursue all your goals.