Party like it's 1999? - MMM v5-49

As I've said since the election, there is no point right now trying to predict what will happen over the next year (or four). Based on my inbox, everyone has their predictions. Maybe it's because their marketing people tell them they have to, but based on my experience there is little to base these predicti0ns on.

My best attempt at 'predicting' what will happen was written the week after the election. You can summarize it as, "Things will not be as great (or dire, depending on your political leanings) as everyone believes they will be right now." If you're finding yourself believing nothing can go wrong, I'd encourage you to take some time to read this:

......or this:

Entering the final month of the year, we are also being bombarded with predictions about the year ahead. These human driven predictions all start with an "anchoring" bias where they start with the average return for stocks and then predict whether it will be better or worse than average. One thing that most people forget is how few times the stock market returns for a calendar year are within 1% of the average. That doesn't stop the range of predictions typically being somewhere between 7-12% for the year ahead.

As I often remind our advisors and clients, the market is a 'mean reverting mechanism". What I mean is the way we get to a 10% average when we have years where the market is up 20 or even 30% is we end up having a year (or two) which is BELOW AVERAGE. To average out to 10% when you have as many 20% up years means we will have some big losses which essentially nobody on Wall Street will predict.

The only time in my memory I've seen a Wall Street firm predict a NEGATIVE calendar year return was heading into 2022 when Morgan Stanley 'boldly' predicted a 5% drop for stocks. Every other Wall Street firm other than BMO was predicting a "below average" return around 5-7%. Obviously they were all off -— by a lot.

Keep this in mind when you see the predictions rolling out. With investing setting proper expectations are important. Looking at the chart again, let's focus on the times over the past 50 years where the S&P 500 returned over 20% for the year.

While most predictions are for a 7-12% return for stocks in 2025, I've heard several predictions where the 'expert' makes the case for another 20%+ year. The only time we have seen more than 2 years of over 20% was from 1995-1999 where we enjoyed an astounding 5 years in a row of 20%+ returns. This "new era" was "justified" by "game-changing" technology which spurred wide-spread investment to keep up with the competition. Sound familiar?

I would LOVE to have another 20%+ year for stocks. It helps everyone. The problem is eventually the stock market is going to revert back to the mean. The longer it stays above it, the more painful the mean reversion will be (notice the 2000-2002 mean reversion for stocks).

My message remains the same – enjoy these returns, but DO NOT INCREASE YOUR ALLOCATION SIMPLY BECAUSE YOU WANT EVEN HIGHER RETURNS. The only time you should make a change to your investment portfolio is if something has changed in your financial plan, cash flow strategy, or risk personality.

In our "buy high, sell higher" series, we discussed the concept of FORWARD RETURN EXPECTATIONS. Essentially, your long-term (10-year) returns are based on WHERE YOU START. The higher the valuation (or the move above the long-term trend) the lower your future returns will be. You can check out the whole series here:

Over the weekend, I did read a few predictions that stocks are set to under-perform bonds in the coming years. Of course these predictions are still calling for stocks to have positive returns, but based on where we are with valuations and interest rates, bonds could be set for a period of outperformance. I'm not sure what the next year will give us, but long-term based on history, bonds (and the much maligned 60/40 portfolio) should see a rebound in performance and stocks should see some "below average" returns.

For now, though the "trend is your friend" and the "trend" is higher. More on that and SEM's positioning below.

Market Charts

"Higher highs tend to lead to higher highs.......until something significant comes along to change it."

That's been my theme of the last 2 years. Right now few people believe anything significant will come along. While there has clearly been some enthusiasm driving stocks higher since the election, my hope is President Trump will not do what he did during his first term and use the stock market has the measure of whether or not his policies are a good idea. The promises which won him a second term all will require SHORT-TERM sacrifices to actually make an impact.

The current trend and bottom of the market came about a year ago when the Fed essentially said they were done raising rates and were ready to start cutting them.

Going out even further we can see why it doesn't make sense to claim the President is the reason stocks will go higher (or lower). If so, Republicans would have to give President Biden credit for some impressive returns even with the bear market in 2022.

As a reminder, here is what the DATA says — Trump's first term was 'above average', but it was actually below the "Biden" market. More importantly, Trump's first term was filled with EXTREME Volatility, even before the pandemic.

Really the more important chart will be interest rates. This will determine the ability for Trump and his supporters to push through a lot of his policies. If rates go higher, it will make every policy that much more expensive. With a slim majority in the House it could be difficult. For now, rates have taken some of the pressure off, but are still uncomfortably high.

SEM Model Positioning

-Tactical High Yield had a partial buy signal on 5/6/24, reversing some of the sells on 4/16 & 17/2024 - the other portion of the signal remains on a sell as high yields continue to oscillate.

-Dynamic Models are 'neutral' as of 6/7/24, reversing the half 'bearish' signal from 5/3/2024. 7/8/24 - interest rate model flipped from partially bearish to partially bullish (lower long-term rates).

-Strategic Trend Models went on a buy 11/27/2023;  7/8/24 – small and mid-cap positions eliminated with latest Core Rotation System update – money shifted to Large Cap Value (Dividend Growth) & International Funds

SEM deploys 3 distinct approaches – Tactical, Dynamic, and Strategic. These systems have been described as 'daily, monthly, quarterly' given how often they may make adjustments. Here is where they each stand.

Tactical (daily): On 5/6/24 about half of the signals in our high yield models switched to a buy. The other half remains in money market funds. The money market funds we are currently invested in are yielding between 4.3-4.8% annually.

Dynamic (monthly): The economic model was 'neutral' since February. In early May the model moved slightly negative, but reversed back to 'neutral' in June. This means 'benchmark' positions – 20% dividend stocks in Dynamic Income and 20% small cap stocks in Dynamic Aggressive Growth. The interest rate model is slightly 'bullish'.

Strategic (quarterly)*: BOTH Trend Systems reversed back to a buy on 11/27/2023

The core rotation is adjusted quarterly. On August 17 it rotated out of mid-cap growth and into small cap value. It also sold some large cap value to buy some large cap blend and growth. The large cap purchases were in actively managed funds with more diversification than the S&P 500 (banking on the market broadening out beyond the top 5-10 stocks.) On January 8 it rotated completely out of small cap value and mid-cap growth to purchase another broad (more diversified) large cap blend fund along with a Dividend Growth fund.

The * in quarterly is for the trend models. These models are watched daily but they trade infrequently based on readings of where each believe we are in the cycle. The trend systems can be susceptible to "whipsaws" as we saw with the recent sell and buy signals at the end of October and November. The goal of the systems is to miss major downturns in the market. Risks are high when the market has been stampeding higher as it has for most of 2023. This means sometimes selling too soon. As we saw with the recent trade, the systems can quickly reverse if they are wrong.

Overall, this is how our various models stack up based on the last allocation change:

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