Q4 2024 Review: The Other Revolution

In our last newsletter we wrote about the impending political revolution, but 2024 was defined by a different revolution: Artificial Intelligence. At least that’s what the stock market suggests. The seven largest companies (Apple, Nvidia, Microsoft, Amazon, Meta, Tesla and Google) now represent 33% of the S&P 500. This compares to 22% during the internet bubble 25 years ago and is akin to the 1960s with the nifty-fifty reigned supreme.

Given their size, the change in value of these stocks inevitably determines “market” performance. The last two years were unprecedented with the largest companies driving the largest returns:  Nvidia (+819%), Apple (+94%), Microsoft (+78%), Amazon (161%), Meta (+388%), Tesla (+227%), and Google (+115%). As a result, the number of stocks outperforming the index fell to a record low (see chart). This explains the discrepancy between the market-cap weighted S&P 500 (+25%) and the equal-weighted version (+13%). In a time of such high market concentration, what’s an investor to do?

As exciting as the future may be, revolutions are extraordinarily disruptive! Think back on the major technological changes over the past centuries. Most recently, the dot-com bubble and fiber build out in the late 1990s. Or the mid-1800s, when railroad tracks were laid across the country. The infrastructure built provided immense public value over time, but there were significant manias and collapses along the way. Economist Alex Tabarrok believes, “The intelligence revolution is going to be bigger, more impactful and more wrenching than the industrial revolution.”

Even so, the market is giddy about the possibilities. According to survey measures, expectations for higher stock prices over the next 12 months are at record highs. Risk appetite is strong with corporate bond spreads at record lows, and equity valuations well above average. This comes after two historically strong years in the US stock market.

However, take out AI and the rest of the market was a mixed bag. Many healthcare and industrial stocks are still recovering from a Covid overhang, not to mention the threat of tariffs and regulation. Consumer stocks delivered uneven performance as low-income households struggled with high inflation. Oil and gas pipelines marched higher on the prospects of deregulation, but producers languished with low prices. And while Nvidia increased almost 200%, the median semiconductor company was negative on the year. 

A market like this presents us with two options. The first is to jump abord the AI train and hope to jump off before the inevitable market recalibration happens. This is a big gamble. The second is to take the more conservative approach and put a greater weight on industries less likely to be disrupted by AI, and that may even benefit from it in the long run. That sounds better to us, particularly when the market has given up on them. 

The fact is our portfolios will always underperform in a mania, and that is ok. Inevitably, the tide will go out, like it always does after a gold rush, and we will be thankful we didn’t get caught in the current. In the meantime, we’ll enjoy the tailwinds of the ride and remain focused on investing rather than speculating with our clients’ futures. There is no revolution required to own good businesses and buy them at reasonable prices. 

Even as we navigate the challenges of a manic market, we remain encouraged by the progress within our portfolio. The turnarounds at Citibank and VF Corp are well on their way, and while we wait for Danaher’s bio-tech end markets to recover, depressed healthcare valuations play right into the company’s acquisition sweet spot.

After a difficult fourth quarter, Option Care Health resolved its supplier issue and is back on track for double-digit growth and significant share repurchases. In the industrial tech sector, TE Connectivity’s earnings are likely to inflect higher once auto manufacturers finally burn through excess inventory for sensors, a key input for autonomous vehicles. And if the economy is indeed set for a boom, we are going to need a lot more oil and gas, benefiting Chevron and EOG.  

From a macro standpoint, it’s anybody’s guess as to how the intersection of stubborn inflation, confrontational international trade and tariff policy, deportation, large budget and tax cuts, deregulation, and the host of other potential changes under the Trump revolution will impact the economy. An economy that is in great shape relative to the rest of the world, and that could be juiced further by the animal spirits unleashed by a pro-business administration.

Yet higher interest rates appear to be here to stay, which could take some of the steam out of the excitement. We’ll find out soon enough. In the meantime, short-term bonds, and a little extra high yielding cash offer the best complement to our diversified equity portfolios to offset any volatility ahead.

On a final note, our hearts are with our friends, clients, and everybody else impacted by the Los Angeles fires. Given the increasingly challenging insurance markets throughout much of the country, this is a reminder of how important it is to review your policies annually. We are happy to help. 

Wishing you a successful and fulfilling 2025.

_{Compass Wealth Management LLC is a SEC registered investment advisor, clearing transactions primarily through Pershing Advisor Solutions and Pershing LLC subsidiaries of Bank of New York Mellon Corp. This letter is written by Compass for the benefit of its clients and does not necessarily represent the opinions of its affiliated organizations. It is based on information believed to be reliable, but which is not guaranteed to be correct. Nothing herein shall be construed to be a solicitation to buy or sell securities, indicate that past performance is predictive of future returns, or recommend individual investments.}