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2024: Invincibility Syndrome

Summary Points:

  • The most significant feature of this investment year is the perception that US equities are virtually invincible. This “Invincibility Syndrome” historically signals a crescendo when markets are in the process of summiting a major peak.
  • The decline of long-term risk-free yields appears complete, unless the soft-landing assumption is badly wrong. The landscape taking shape represents a prelude to a much more disturbed period ahead.
  • Today’s investment world is a prisoner of the assumptions of quasi-price stability and monetary dominance. This is gone whatever the central bankers may claim. In its place is a world of conflict, government interventionism, protectionism and fiscal dominance.

The excess returns delivered to investors in 2024 have been driven by substantially positive macro-economic and policy surprises. Inflation has subsided despite resilient growth and earnings, allowing the Fed to declare monetary victory, and upbeat investors are projecting these favorable conditions into the future. How should we interpret the latest upward break-out by equities, with the S&P 500 pushing toward the 6000 threshold?

In our view, the paradox of this rewarding year is its underlying warning of low future returns for 2025 and beyond. There are those who expect the S&P 500 to push higher into early 2025 based on the belief that the only electoral outcome capable of disrupting this inevitability would be extended political uncertainty. If November provides a clear resolution, 2024 could go down as the most rewarding year for US large-cap equities of this century.

And yet, this thought pales in comparison to the most significant feature of this investment year—the perception of the virtual invincibility of US equities, which has emerged within large parts of the investment community. This is the conundrum: an “Invincibility Syndrome” signals a crescendo. It has historically emerged when markets are in the process of establishing a major summit.

A fair number of investors will agree that it is more challenging to identify major market tops than bottoms1. Major equity troughs are invariably accompanied by visible fundamental and psychological distress; fear can quickly become acute, whereas investor optimism can become a chronic condition. Equity summits are typically extended and marked by rotation as narratives across different styles and industry segments are pushed to exhaustion.

What all major equity tops—those of more than tactical significance—have in common is what we term the invincibility syndrome. This is more than an intriguing slogan. It can be drawn from data whose characteristic components have historically included valuation, sentiment and positioning. Each can be measured by widely available indicators when approaching extended or unsustainable levels.

The metrics that signal elevated valuation are so familiar that they need little review. The standard Shiller cyclically adjusted P/E ratio for US equities has risen to over 35, the third highest on record and only surpassed when bond yields were unsustainably low. The median P/E of the S&P 500 is 28X, last hit during the dotcom peak of 1999. Price-to-sales measures are back to levels last seen at the equity peak of 2021.

The nuance is that the “excess” relates to an island within a sea of greater or lesser value—specifically, the US technology-led growth universe. The leadership of this equity segment emerged in the years following the GFC. It has been so overwhelming since 2014 that commitments to this US dollar-denominated style has become synonymous with equity investment for most of the recent converts.

A phenomenon of this magnitude should not be discounted as an egregious case of speculative enthusiasm. It is the consequence of the disintegration of the globalization era and therefore has a genuine underpinning. In today’s new world of fragmentation, strategic risk has returned with a vengeance. It affects the fragile periphery of the world economy more than its core and international investors have voted with their feet, converging on the US.

In this light, there is an inevitability behind the strategic premium for American growth in today’s illiberal landscape of fragmentation, conflict and big government that characterizes the post-Covid world. US growth assets have generally benefited from this emergence of a premium as the globalization parenthesis of the neo-liberal era has closed.

For this very reason, we suspect that the US dollar is condemned to experience a large degree of overvaluation for most of this decade, contrary to received wisdom.

As long as conflict and protectionism are reasonable expectations, we believe capital will flow naturally to a US system whose strategic attributes have become more and more valuable. There’s a perception that only America can be considered militarily secure within its borders, benefiting from independence with respect to energy and most technological inputs and without undue reliance on exports.

Amid this, the US remains the predominant source of investment capital, especially for the technological innovation, which is a precious comparative advantage and stimulated by a US-China arms race. The comparative undervaluation of ex-US assets is the other side of the coin. The resilience displayed by the US economy contrasts with the accumulating structural weaknesses of Europe, Japan and China.

We should therefore be careful in concluding that the rise in absolute and relative valuation of US equity growth is unsustainable if it is a structural consequence of “deglobalization” (or its political translation, “Reindustrialization of America”). Any diagnosis of today’s landscape should attach at least as much significance to investor positioning and sentiment as to equity valuation.

Sentiment and Positioning

There are numerous barometers of investor sentiment, some with long and reliable pedigrees. There are direct surveys of sentiment including those of the NAAIM2, Investor Intelligence and newsletters such as the “Hulbert Survey.” The general message is that confidence in the outlook for stocks has reached levels that have rarely been higher.

To cite one example, the Conference Board’s monthly survey of the American consumer includes a question about the prospects for stock prices over the year ahead. As shown below, the three-month moving average of this series has risen to its highest level on record. Newsletter writers monitored by the “Hulbert Survey” corroborate this: they have become more bullish than at any time since 2000.

Conference Board Consumer Confidence Expectation Stock Price Increase

1987 to 2024: 3-Month Moving Average

Chart1.png

Source: Macrobond

Investor sentiment speaks little about the scale of risk, but extreme readings become significant when they signal the same message as measures of valuation and positioning. What is striking today is how positioning measures corroborate the diagnosis of extended confidence and valuation for the leading categories of US equities. What remains to drive a market higher if everyone is already bullish?

The allocations of global and US investors convey a similar message—that cash allocations are near the lowest levels versus history. This mirrors the message of cash on household balance sheets as a share of total financial assets3. On the surface, there is little cash to propagate financial assets or to cushion declines in the event of a shock.

1950 to 2024: Household Equity as % of Assets

Chart2.png

Source: Federal Reserve Bank of St. Louis

1999 to 2024: Cash Allocations by Global Investors

Global cash held by non-bank investors as % of total holdings of equities/bonds/M2

Chart3.png

Source: JP Morgan Research, “Flows & Liquidity, how low are cash allocations?” October 9, 2024, using Bloomberg Finance LP, JP Morgan.

There is a popular idea that the ~$6 trillion of funds invested in money market assets is available to push stocks higher. However, when measured relative to equity capitalization there is nothing exceptional about the current scale of money market funds4. Cash as a percentage of assets in equity mutual funds has reached historically low levels.

All of this speaks to vulnerability, but without answering the paramount question: What is the mechanism of trend reversal in the language of macro-economics? In the context of the “strategic premium” earned by US equities, what are the “catalysts” and the related question of "how"?

Catalysts Always Emerge

The kernel of our answer is straightforward: today’s investment world is the prisoner of the assumptions of quasi-price stability and monetary dominance. In our view, this is gone whatever the central bankers may claim. In its place is an illiberal world of conflict, government interventionism, protectionism, populism and fiscal dominance.

There is a tenacious belief that only a recession is capable of killing the current bull market. After all, the inflation surge of 2022 failed to do so. Yet, the counterpart of the invincibility syndrome is today’s economic wishful thinking—most likely around inflation and interest rates. The bear market of 2000–2003 highlights that recession can be a consequence rather than a cause of asset price deflation.

The investment consensus expects earnings growth for the S&P 500 through 2025 of 10%–15% based upon an assumption of sustained economic growth. In this scenario, there is no value in longer-dated US Treasuries and the neutral Fed funds rate should not be below 3%. In the context of quasi-permanent fiscal expansion, the steepening of the yield curve should prevent the US 10-year yield from descending below 3.5%.

Put simply, the decline of long-term risk-free yields appears complete, unless the soft-landing assumption is badly wrong. The landscape taking shape represents the final stages of the bull market and a prelude to a much more disturbed period ahead, perhaps for many years.

Threshold 6000?

Amid the policy drama of the past quarter, the fundamental debates for 2025 have changed little. For the past year, investors have been discounting a soft landing with disinflation, while expectations of a Fed easing cycle have proven correct so far. Recession worries seem premature, though moderating US economic activity is the central case into 2025. This is not a terrible outlook, just one that lacks the upside oomph to justify the S&P 500 forward multiple of around 21 times consensus earnings.

In an absence of economic stress, there are no significant novelties to exploit across the current equity landscape. This is why Fed easing may not matter much. Valuation spreads are not at provocative levels, sitting about half a deviation above the mean and signaling investor comfort with the benign and accepted fundamental outlook. We believe the rush to buy China-exposed stocks in recent weeks is an indication of investor appetite for new narratives when everything else has run its course.

China’s leadership is panicky. Its latest move implies that things are getting worse. Recognizing the scale of the problem is a start, yet the debt restructurings required to resolve this are complex and politically charged. Price momentum can be powerful for a time, but much of this is wishful thinking if China is not changing course on the big issues anytime soon. It will not operate according to Western norms.

The benign interpretation is that President Xi is tactical and the Party is pragmatic and policy is now bending to reality—much as it did with the sudden U-turn from zero Covid. A multi-faceted U-turn on economic policy could mark a watershed rebalancing of its development strategy. But this will be arduous and take years to execute, even if the leadership has the clarity and will amid today’s hostile global setting.

Today’s “invincibility syndrome” implies that when financial markets change their mind, they can do so in a profound way. And the one major insight may be that risks are more skewed to the downside in 2025 and a more diversified approach is appropriate. Calamos has a long history of navigating such complexity with its risk-adjusted product suite. Our long/short mandates are now emphasizing alpha over beta, with the lowest levels of net equity exposure since late 2019.

Our founder, John Calamos, Sr., served as a US Air Force pilot in the Vietnam War and trained to trust his instruments regardless of what he saw outside the cockpit. Investors are looking for a Fed easing cycle that implies good weather ahead, yet the instruments are flashing amber. There are few large anomalies to exploit, particularly on the upside. In these circumstances, investors should maintain the disciplines that have always proved their value.

A push to the 6000 threshold for the S&P 500 implies that 2024 will be the most rewarding year for US large-cap equities of this century so far. And yet, this thought pales in comparison with the growing evidence that we are witnessing a crescendo— a summit for equities that could prove durable.

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1This excludes the cases in which exogenous shocks produce precipitous decline.

2The NAAIM Exposure Index is a weekly survey conducted by the National Association of Active Investment Managers, an organization representing investment advisors who utilize active management strategies to manage their clients’ portfolios.

3According to US flow of funds data, the allocation to equity of US households as a percentage of their total financial assets has risen to a record high of 34.7%. Major previous high points were registered by this metric in 1968 (29.5%) and 2000 (30.9%).

4In previous bear markets the ratio of MM funds to equity capitalization has risen to 30–50% compared with approximately 15% at this time.

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Price/earnings ratio is the current stock price over trailing 12-month earnings per share.

S&P 500 Index is generally considered representative of the US stock market.

Price/sales ratio is a stock’s capitalization divided by its sales over the trailing 12 months.

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