So far, 2024 has been a great year for the stock market. Through the end of November, the S&P 500 Index has gained 28.06%, which is all the more impressive considering it is coming on the back of a 26.26% gain in 2023. To be sure, a lot of good things have happened that caused stocks to enjoy such strong gains. An economic soft landing, lower rates of inflation, the Fed cutting interest rates, strong corporate earnings and a productivity resurgence are a complete recipe for a raging bull market.
The problem is, investors have gotten used to these types of gains, and it seems they have come to expect more of the same. Since 1987, the consumer confidence survey of The Conference Board has been asking their respondents (a random sample of about 3,000 households) whether or not they expect stock prices to rise in the near future. The latest reading of 56.4% is the highest on record, indicating a widespread optimism concerning the stock market.
Source: CWA, Bloomberg, The Conference Board, as of 11/26/2024
This is a problem because, as it is often said, bull markets climb a wall of worry. If the wall of worry has crumbled, then further gains may be more difficult to come by. In other words, if everyone is bullish, then who is left to buy?
The table below reports the average forward return and drawdown of the S&P 500 index from different starting points of the consumer confidence series shown above, based on all available data since 1987. The numbers confirm our suspicions: high levels of stock market optimism tend to be followed by below-average market returns, and by deeper-than-average drawdowns.
Source: CWA, Bloomberg, The Conference Board, as of 11/26/2024
This doesn’t mean it is time to hit the panic button and sell all your stocks. Afterall, the table above shows that even periods of excessive optimism are followed by positive returns on average. Moreover, with many of the positive catalysts mentioned above set to remain intact in the near future, it is quite possible that investor optimism will prove correct for a while longer, and may even go from optimism to outright euphoria, taking the market higher with it.
That being said, the odds that 2025 will be as good as 2023 and 2024 for the stock market seem low. In addition to the high bar being set by elevated investor optimism (and elevated valuations), 2025 will be the first year of a new presidential cycle and the third year of the bull market that began in late 2022. From a statistical standpoint, both factors point to more muted stock market returns, and the potential for more volatility. So, we think this is a great opportunity to review one’s portfolio to make sure it is aligned with one’s risk tolerance and long-term goals, especially since allocations to stocks may have drifted higher, and make adjustments as needed.
Sauro Locatelli CFA, FRM®, SCR®
Director of Quantitative Research
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