Financial markets have been turbulent since the November election, and with good reason. With the next presidential administration promising sharp policy changes on a wide range of economic issues, there is plenty to be nervous about.
The new proposals are staggering. President-elect says he wants to deport millions of immigrants; impose tariffs on all countries, especially China; reduce taxes; expand the use of cryptocurrency; eliminating wind-powered electricity generation; and increase fossil fuel production.
It is impossible to know which policies are fanciful, which policies will be implemented, and what all the economic and market consequences might be. No wonder the markets are in disarray.
But if you need comfort, most investors just need to check their portfolios. If you've owned stocks since late 2022, when the market picture radically improved, chances are your portfolio has performed spectacularly. All you really had to do was hold a portion of the broad U.S. stock market in a low-cost, diversified index fund. Bond returns have been mediocre, as evidenced by the latest annual portfolio performance data for ordinary investors, but US stocks have paid off, with annual returns for the S&P 500 of around 25 percent, including dividends, for each of the last two calendar months . year.
While these gaudy returns are reassuring – especially after the disasters of 2022, when inflation soared, interest rates rose and both stocks and bonds fell in value – they are not predictions. No one knows where the stock, bond and commodity markets will end up once 2025 rolls around.
But history teaches us a sobering lesson: stocks and sectors go out of fashion. What worked for the past two years may not work for the next two years. Periods of excessive returns are sooner or later followed by market declines.
I have no idea where the markets are going in the short term. But if you want to reduce the volatility of your investments in the coming years, I think it's important to look beyond US stocks and the handful of big tech companies that have been driving domestic returns lately. Also hold diversified fixed income investments, as well as a wide range of international stocks.
Recent returns
After a brief surge from Election Day through Nov. 11, stocks stalled, and through the final three months of the year, the average U.S. domestic stock fund rose less than 1 percent, according to Morningstar, the financial services firm. The average actively managed fund lagged the broad, large-cap S&P 500 index, which rose 2.3 percent in the quarter.
Performance in the quarter was worse for bond funds. Taxable funds lost 2.5 percent; municipal bond funds lost nearly a percentage point.
The culprit has been rising interest rates, which have risen despite the Federal Reserve's cuts in short-term interest rates. The bond market's assessment of the economy – and the inflation risks posed by the new administration's policies – is less optimistic than the Fed's. The market sees a great chance of sharply rising prices; While there are differing opinions within the Fed, overall the central bank believes that inflation is going down. Rising bond yields are also likely to blame for the stock market slump.
When you look back to 2024 as a whole, investment returns look better. Domestic stock funds rose 17.3 percent this year, though they lagged the S&P 500 badly. BofA Global Research, a part of Bank of America, found that 64 percent of actively managed large-cap funds failed to capture the market to beat. This underperformance has been a regular occurrence for decades, Bank of America notes. That poor track record is why I rely primarily on broad index funds, which simply try to match market returns.
Most bond funds posted modest gains this year. According to Morningstar, taxable bonds yielded 4.5 percent and municipal bonds returned 2.7 percent.
Most international equity funds have not kept pace with their US counterparts. They lost 6.7 percent for the quarter and gained 5.5 percent for the year.
Taking risks
To get the best returns, you had to place bets on certain companies or sectors, and be smart or lucky enough to get it right. Investments bathed in the glamor of artificial intelligence were big winners in 2024. Nvidia, which makes chips for AI, won 171 percent. It trailed just two other S&P 500 stocks. One of these was Palantir Technologies, a military contractor using AI, which delivered a return of 340.5 percent. The other was Vistra, a nuclear power plant operator that has found itself in high demand due to the voracious energy needs of companies developing AI; it increased by 258 percent.
According to Morningstar, technology funds are up 31.1 percent this year. The Semiconductor UltraSector ProFund rose 106 percent, mainly thanks to Nvidia. That stock accounted for more than half of the assets of the fund, which also used derivatives to boost its results. As great as this strategy was last year, it would mean big losses if Nvidia were to falter.
Funds focused on banks – which last year were able to borrow money at low rates thanks to the Fed and lend at much higher rates thanks to the bond market – also flourished, returning 27.6 percent for the year.
Then there was MicroStrategy, whose main business is buying and holding Bitcoin. MicroStrategy rose 359 percent in 2024, a windfall that will evaporate if Bitcoin goes out of fashion, as it will in 2022.
Most people investing for retirement took fewer risks – and reaped fewer returns – but still earned strong returns. Funds with an allocation of 50 to 70 percent to stocks, and the rest to bonds, rose an average of 11.9 percent this year, according to Morningstar. Those with 70 to 85 percent in stocks, while the rest was in bonds, rose more than 13 percent. High-quality bonds depress investor returns, but have historically been safer than stocks and are often a balm when the stock market falls.
Think of the '90s
Technology stocks have improved returns before. They were the key to excellent market performance in the 1990s, the dot-com era. From 1995 through 1998, the S&P 500 gained more than 20 percent annually, closing in on 20 percent in 1999, largely thanks to technology stocks.
But the market rose too high and formed a bubble that burst in March 2000. From that year onwards, the shares experienced three consecutive years of catastrophic losses. If you first invested in stocks in late 1999, your holdings would have been underwater well into 2006. The returns over an entire decade were disappointing.
By some measures, stocks aren't as extravagantly priced today as they were then, but they're high enough to be concerning. As a permanent investor, I strive for solid returns my entire life, and I'm well aware that years of gains can be wiped out by a market crash if you're not prepared for trouble.
That's why I hope for the American market not rising too quickly now. A stock market correction – defined as a decline of at least 10 percent and less than 20 percent – could even be a good thing, as long as the economy and corporate profits continue to grow. Classic valuation metrics such as the price-to-earnings ratio could become more attractive and spur further gains in the US stock market.
That said, it seems foolhardy to bet entirely on US stocks right now, especially tech stocks, given their high levels and the extreme uncertainty in the political world. Relatively speaking, bonds are competitively priced, and major international stock markets and overlooked parts of the U.S. stock market can offer bargains.
I'm not suggesting you have to choose between these different sectors or asset classes; just that your portfolio contains a little bit of all. If stocks rise again, rebalance your investments to restore a mix of assets you can live with.
I'm not getting the best available returns because I'm hedging my bets. It's been a great run and I'm hoping for more solid gains in the stock market, but I'll try to be well prepared when the next storm arrives.
