Financial markets have been choppy since the November election, and for good reason. With the next presidential administration promising sharp policy changes on a broad range of economic issues, there is plenty to be nervous about.
The new proposals are dizzying. The president-elect says he wants to deport millions of immigrants; impose tariffs on all countries, especially China; slash taxes; expand the use of cryptocurrency; eliminate wind-powered electric generation; and increase production of fossil fuels.
It’s impossible to know which policies are fanciful, which will be carried out or what all the economic and market consequences might be. No wonder the markets are confused.
Still, if you need solace, most investors need only check their portfolios. If you have held stocks since the end of 2022, when the market picture improved radically, there’s a good chance that your portfolio has had a spectacular performance. All you really needed to do was hold a piece of the broad U.S. stock market in a cheap, diversified index fund. Bond returns have been mediocre, as the final annual numbers on the portfolio performance of ordinary investors reveal, but U.S. equities have paid off handsomely, with annual returns for the S&P 500 of roughly 25 percent, including dividends, for each of the last two calendar years.
While those gaudy returns are comforting — especially after the calamities of 2022, when inflation soared, interest rates rose and both stocks and bonds sank in value — they aren’t predictions. No one knows where the stock, bond and commodity markets will end up when 2025 is over.
But history suggests a sobering lesson: Stocks and sectors go out of fashion. What worked over the last two years may not work in the next one. Periods of outsize returns are followed by market declines, sooner or later.
I have no idea where the markets are going over the short term. But if you want to reduce the volatility of your investments in the years ahead, I think it’s important to go beyond U.S. stocks and the handful of big tech companies that have been driving domestic returns lately. Hold diversified, fixed-income investments, too, as well as a broad range of international equities.
Recent Returns
After a brief surge from Election Day through Nov. 11, stocks stalled, and for the last three months of the year, the average U.S. domestic stock fund rose less than 1 percent, according to Morningstar, the financial services company. The average actively managed fund lagged the broad, large-capitalization S&P 500 index, which gained 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 was rising yields, which have been increasing despite the Federal Reserve’s cuts in short-term interest rates. The bond market’s assessment of the economy — and of the inflation risks posed by the incoming administration’s policies — is less sanguine than the Fed’s. The market sees a strong possibility of sharply rising prices; while there are a range of opinions within the Fed, the central bank overall has judged inflation to be heading downward. Rising bond yields are likely behind the stock market’s stumble, too.
When you extend your gaze back to 2024 as a whole, investment returns look better. Domestic stock funds rose 17.3 percent for the year, though they badly underperformed the S&P 500. BofA Global Research, a unit of Bank of America, found that 64 percent of actively managed, large capitalization funds failed to beat the market. That underperformance has been occurring regularly for decades, Bank of America found. That poor record is why I rely mainly on broad index funds, which merely try to match market returns.
Most bond funds eked out modest gains for the year. Taxable bonds returned 4.5 percent and municipal bonds 2.7 percent, according to Morningstar.
Most international stock funds didn’t keep up with their U.S. counterparts. They lost 6.7 percent for the quarter and gained 5.5 percent for the year.
Risk Taking
For the best returns, you needed to place bets on particular companies or sectors, and be smart or lucky enough to get it right. Investments bathed in the glamour of artificial intelligence were big winners in 2024. Nvidia, which makes chips for A.I., gained 171 percent. It trailed only two other S&P 500 stocks. One was Palantir Technologies, a military contractor that uses A.I., which returned 340.5 percent. The other was Vistra, an operator of nuclear power plants that have come into high demand because of the voracious power needs of companies developing A.I.; it rose 258 percent.
Technology funds gained 31.1 percent for the year, according to Morningstar. The Semiconductor UltraSector ProFund rose 106 percent, mainly because of Nvidia. That stock accounted for more than half the assets of the fund, which also used derivatives to magnify its results. Marvelous as this strategy was last year, it would produce big losses should Nvidia falter.
Funds that concentrated on banks — which could borrow money at low rates last year, because of the Fed, and lend it out at much higher ones, thanks to the bond market — also prospered, with a return of 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 did in 2022.
Most people investing for retirement took fewer risks — and reaped lesser rewards — but still had strong returns. Funds with an allocation of 50 to 70 percent stock, with the remainder in bonds, gained 11.9 percent for the year on average, Morningstar said. Those with 70 to 85 percent stock, with the remainder in bonds, rose more than 13 percent. High-quality bonds pulled down investor returns, but they have historically been safer than stock and are often a balm when the stock market falls.
Remember the ’90s
Tech stocks have bolstered returns before. They were the key to outstanding market performance in the 1990s, the dot-com era. From 1995 through 1998, the S&P 500 gained more than 20 percent annually, and came close to 20 percent in 1999, largely on the strength of tech stocks.
But the market rose too high, forming a bubble that burst in March 2000. Starting that year, for three consecutive years, stocks had catastrophic losses. If you invested in stocks for the first time in late 1999, your holdings would have been underwater until well into 2006. Returns for an entire decade were disappointing.
By some metrics, stocks aren’t as extravagantly priced today as they were then, but they are high enough to be concerning. As a permanent investor, I’m seeking a solid return over my entire lifetime, and I’m acutely aware that years of gains can be wiped out in a market crash, if you aren’t prepared for trouble.
That’s why I’m hoping the U.S. market doesn’t rise too rapidly now. A stock market correction — defined as a decline of at least 10 percent and less than 20 percent — might even be a good thing, as long as the economy, and corporate profits, keep growing. Classic valuation metrics, like the price-to-earnings ratio, might become more attractive and set up the U.S. stock market for further increases.
That said, it seems reckless to bet entirely on U.S. stocks now, especially technology stocks, given their elevated levels and the extreme uncertainty in the political world. Comparatively, bonds are competitively priced, and major international stock markets and overlooked portions of the U.S. stock market may offer bargains.
I’m not suggesting that you choose among these different sectors or asset classes; just that your portfolio contains a bit of all of them. If stocks take off again, rebalance your holdings to restore a mix of assets that you can live with.
I’m not getting the best returns available, 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 will try to be well prepared, when the next storm comes in.