Is it time to panic?

On December 11, 2024 we published our newsletter titled Are You Asking Yourself the Right Questions? We wrote that letter in response to the large number of inquiries we were receiving about how the Presidential election result might impact financial markets. We acknowledged that some of our clients were concerned that markets might react negatively; while others were very bullish on prospects for the economy, stock, and bond prices. 

We expressed bullishness on stock prices for 2025, but I also said: “My personal feeling is that stock prices have run up a lot in 2024 and no one should be surprised if we get a quick 5-10% correction. That would blow some froth off the market and possibly reset prices for the next leg up of a multi-year bull market.” 

The day that letter was published the S&P 500 closed at 6084. As I am writing this one, the morning of January 13th, it’s at 5800. That’s just shy of a 5% correction. If this correction deepens to -10% that would take the S&P 500 down to 5475. That’s where it was in early September 2024. The IWM ETF, which represents the small-cap Russell 2000 index, peaked at 244.25 in late November 2024. It hit a low yesterday at 213.97. That’s a correction of about -12.4%. 

This correction shouldn’t have taken anyone by surprise. Corrections like this are common. CharlesSchwab.com reports that the “S&P 500 has experienced a 5% drawdown every year since the early 1980’s with the exceptions of 1995 and 2017. A 10% correction in the S&P 500 is certainly a big deal. However, it's also more common than you might think. Between 2002 and 2021, the market fell at least 10% in 10 of 20 years, with an average pullback of 15%”. Stock prices were down over 20% in 2022. All of these corrections started when prices had moved up too much. Fear and greed drive markets. There was too much greed priced into stock prices by late November and early December of 2024. Now we are seeing fear priced in. That brings us to the title of this letter! 

We don’t believe it’s time to panic. It never is. We want to see investors properly allocated to asset classes that fit their investment goals and risk tolerance. We are writing this letter to acknowledge that 2025 is getting off to a rough start for both stock and bond prices. If you are worried I suggest you go back and read that December 11th newsletter again, or for the first time! You can find it by clicking here. or visiting our website and clicking on Archived Newsletters. 

We also wrote “being bullish or bearish on the bond market in 2025 is a tougher call”. In early December market mavens were counting on the Fed to cut short term rates on December 18th. That happened. They were also forecasting multiple cuts in 2025. Stubborn inflation numbers and a strong economy have tempered those expectations. Presently the futures market is pricing in only one 20 basis point cut in 2025 (0.20%). Even that may be an aggressive call. Surprises for the bond market have included the resilience of the economy, stubbornly persistent inflation, and the steady march upward of long term interest rates. If the economy continues to do well it’s quite possible there will be no cuts in 2025. Stock prices are still adjusting to that possibility. Q4 2024 earnings reporting season is about to begin. Everyone is anxious to see both earnings and forward guidance for 2025. The quality of earnings season is going to be critically important for setting the direction and tone of the stock market going forward.

The bond market is also extremely important to the stock market. Rising long term yields are clearly worrisome for the stock market. The 10 year U.S. treasury yield bottomed in mid-September 2024, just as the Fed started raising short term rates. This yield, along with other long-term bond yields, has been rising steadily ever since. It’s currently at 4.8% and threatening to break above 5%. We haven’t seen the 10 year yield that high since mid-2007. The 30 year U.S. treasury yield is already above 5%. It got there very briefly in late 2023 before retreating again. Otherwise we haven’t seen 5% 30 year U.S. treasury yields since mid-2009. Higher yields across the yield curve, from the shortest to the longest, are pressuring stock prices and bond prices. 

Chart: 10 year U.S. treasury yield

(Source: Stockcharts.com January 13, 2025)

Remember that bond prices drop as yields rise. The TLT is the exchange traded fund (ETF) that holds U.S. Treasury bonds with maturities of 20 years or more. It peaked in price at 100.23 on September 17, 2024, the day before the Fed started raising short term rates. It’s closing price yesterday was 85.5, a drop of -14.7%. In other words, we’ve already had nearly a -15% correction in long term Treasury bond prices. 

By some indicators the U.S. stock market is currently “oversold” on daily charts, and it wouldn’t surprise us to see stock prices bounce. The current sell off has moved the market from “greed” to “fear”. Here is a screenshot of CNN.com’s “Fear and Greed Index”. I like it because it is a reliable tool, and it’s very visual.

This index is made up of 7 components, 5 of which are flashing “extreme fear”. Personally, I’ve always preferred buying stocks when fear is palpable. Having said that, there are other longer term indicators that haven’t yet reached the extremes we often see at bottoms of corrections. It’s quite possible that stock prices will bounce, only to move lower after the pop. 

Chris Roth, Chief Investment Officer, and I talk daily about all of this. We also talk frequently with our partners at Blackrock and JP Morgan. Chris flew to New York yesterday to visit both companies. In the very short term we are all uncertain about what’s next for both stock and bond prices. The post-election euphoria is gone. We are all aware that major policy changes are coming. We are also aware that we have to wait and see what actually gets proposed and what gets enacted. Trump and Musk both campaigned on a plan to cut at least $2 trillion in Federal spending. On January 9, 2025 Musk backed off expectations and is now targeting $1 trillion. There are plenty of people who don’t expect him to accomplish that. This is one of the reasons that bond yields keep rising. Federal deficit spending is at record levels and some fear it will stay that way. Approximately $3 trillion of Federal debt must be refinanced in 2025. We also know that unless there are serious cuts another $2 trillion of deficit spending will be needed for 2025. A year ago all of that could have been financed with near record low interest rates. In 2025 it will all have to be refinanced at higher rates we haven’t seen since 2007-2009. 

Let’s see what earnings season brings. Good earnings and optimistic forward guidance should boost stock prices. Let’s see what Trump proposes, and what gets passed. Between the two we should get a lot more clarity on the near term direction of both stock and bond prices. 

All the best,
Paul

Paul Krsek
CEO
5T Wealth, LLC
Main (707) 224-1340
595 Coombs St
Napa, CA 94559

Disclosure and Disclaimer - Updated last on March 20, 2024 by Paul Krsek: 

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