NEWS & INSIGHTS  |  FOURTH QUARTER 2024

We're Going Streaking

January 6, 2025

By Mark Oelschlager, CFA

​

On October 23 the Cleveland Cavaliers and their new coach Kenny Atkinson opened the season with a win against the Toronto Raptors.  Two nights later they defeated the Detroit Pistons.  They kept on winning, eventually reaching 10-0 against their old Finals rival Golden State.  But they weren’t done.  After outscoring Charlotte on November 17, the team had 15 wins against zero losses, which tied for the second longest winning streak to start a season in NBA history.  Alas, the defending champion Boston Celtics were waiting next – and they were eager to send a message that they remain the team to beat in the Eastern Conference.  The Cavs were missing some key players but fought valiantly, falling 120-117.  The streak was over, but after some trouble with the Atlanta Hawks, the Cavs have righted the ship and reeled off another 12 wins in their last 13 games.  As we write this, they stand at 29-4, the best record in the league.

The stock market posted some noteworthy streaks of its own in the fourth quarter.  The Dow Jones declined ten consecutive days in December, the longest such streak since 1974, and still managed to post a gain for the quarter!  The number of declining stocks in the S&P 500 exceeded the number of advancing ones for 14 consecutive days - a run of negative breadth that hadn’t happened since 1978.  Like the Dow, the S&P 500 rose for the quarter.

How do we reconcile the weakness in so many stocks with indices grinding higher?  The market is still being propelled by a small number of very large companies.  The ten largest stocks by market value now account for a record 40% of the S&P 500 index.  Remember that there are 500 stocks in the index.  Yet ten of them now represent 40% of that index.  The “Magnificent 7” (Alphabet, Amazon, Apple, Meta Platforms, Microsoft, Nvidia, Tesla) account for about 35% of the index.

For the year, the traditional (capitalization-weighted) S&P 500 returned 25%, while the S&P 500 Equal Weighted Index returned about half that.  2023 saw similar results, with the size-weighted index’s 26% gain just about doubling the equal-weighted one.  This disparity is reminiscent of the late 1990s, which happens to be the last time (until 2023 and 2024) that the S&P 500 posted returns greater than 20% in consecutive years.  In 1998, the cap-weighted index returned over 28%, versus 10% for the equal-weighted one.  1999 also favored the cap-weighted index, 21% to 10%.  So what happened after that?

In 2000, the cap-weighted S&P 500 fell 9%, while the equal-weighted one rose more than 7%.  In 2001, the former fell again, this time by 11%, while the latter declined only 2%.  So, if past is prologue, the average stock is poised to outperform the traditional S&P 500.  We think the odds do favor such a reversal, but it is far from certain, given the strong dynamics of these large companies, which we have discussed in the past.

​

After cutting interest rates by half a percentage point in September, the Federal Reserve (Fed) stuck to its plan to cut interest rates by another 50 basis points in the fourth quarter, despite progress on inflation having stalled.  Core CPI inflation has leveled off around 3%, still a significant distance from the Fed’s stated 2% target.  Chairman Powell continues to describe current monetary policy as restrictive, while the economic and inflation data and the behavior of financial markets suggest otherwise.

​

The reaction of the bond market to these developments has been interesting.  While the Fed has been lowering short-term interest rates, long-term rates, which the Fed does not control, have risen – and not by just a modest amount.  After bottoming at 3.62% two days before the Fed announced its initial rate cut in September, the yield on the ten-year Treasury bond has risen to over 4 ½%.  This is unusual.  Over the last few decades, moves in ten-year yields tended to be much more muted following an initial Fed rate cut, and they tended to move lower, not higher.  It may be tempting to ascribe some of this move in long yields to Donald Trump winning the presidential election, but the bulk of it occurred before his victory.  A couple plausible explanations for the rise are the economy regaining some strength after a summer scare and of course the aforementioned inflation data.

​

When the Fed announced its latest rate cut in December, it also dialed back its rate cutting plans for 2025.  This spooked the market, and the S&P 500 fell almost 3% that day, though it did rebound in the ensuing days.  The market reaction that day is a bit perplexing, as the change in Fed tone had already been anticipated by bond investors, as evidenced by the backup in one and two-year yields.  In fact, yields across the short end of the curve are notably similar right now, meaning bond investors are earning a similar annualized return whether they go out three months or four years.  This is also telling us that the market is not expecting much movement from the Fed in the next few years, at least on a net basis.

​

We have been asked what President Trump will mean for the economy and market going forward.  It’s important to note that the president, no matter who it is, has only so much control over the US economy, and even less of the stock market.  President Trump’s business-friendly stance on regulation and taxes are likely positives, while his affinity for tariffs may hurt economic growth and push inflation higher, though there is some uncertainty about whether his bite will match his bark.  His tougher position on immigration could conceivably lead to a tighter labor market, which could provide another boost to inflation.

​

Stepping back, after such a strong period for stocks, we believe it is important to remind investors that things will not always be this good.  Over the last 15 years the S&P 500 has returned almost 14% annually.  That is a remarkable run for stocks that has likely created unrealistic expectations about future returns and at the same time fostered complacency.  I would put the probability of the next 15 years matching or exceeding those of the last 15 at less than 1%.  And I believe it is likely that returns will fall well short of the 10% long-term average over that period.

​

There will be a major correction at some point.  We don’t know when it will be, but – and this is key – we don’t know when it won’t be.  We saw a poll recently that indicated that very few people expect a correction in the next 12 months.  Such expectations resemble those that existed prior to previous corrections.  Corrections tend to happen when few are expecting them.

​

Given all this, and our read of the environment, our portfolios are positioned relatively defensively, which means we hope to hold up better than the market and other managers in a downturn.  In a time when stock valuations and investor leverage are near all-time highs, Bitcoin is doubling seemingly every year, something called Fartcoin has reached a value of $1 billion, and a piece of art of a banana duct-taped to a wall is selling for over $6 million, it strikes us as a time to not embrace risk.  When the market’s attitude becomes less cavalier, and the risk-reward equation changes, we plan to take some higher-percentage shots, just as we have historically.

​

When 2024 ended, it marked five years since our Towpath Focus Fund was launched.  For every one of those five years, the Fund’s returns placed it in the top half of its Morningstar peer group and ahead of the peer group average.  For the overall period, the Fund’s returns were in the top 2% in its category.  We pride ourselves on being intellectually honest, so we feel compelled to point out that this ranking is a function of the category in which Morningstar places the Fund.  If a different category were selected by Morningstar, the relative rank would likely not be as high.

​

One more item to note on Towpath Focus Fund.  We have worked hard to keep the Fund’s expense ratio (what you ultimately pay to own it) as low as possible.  In addition, we recently made a choice that accelerated the reduction in the expense ratio.  Oelschlager Investments is the advisor to Towpath Focus Fund and earns a fee for managing it.  When a mutual fund is in its early years and the total dollars in the fund are relatively small, some of the fixed costs that are paid by the fund to third parties for administering the fund (e.g. fund accounting, compliance, auditing) tend to be a significant percentage of the fund’s assets.  In order to prevent the fund expenses from rising to too high a level, it is customary for the advisor to waive (forego) some of its advisory (management) fees.  As the fund grows, and the fixed expenses shrink as a percentage of assets, the advisor is able to collect more, and eventually all, of its fee.  But that’s not all.  When the expense ratio gets low enough, the advisor is allowed to recoup the fees that it had foregone.  We decided to waive this recoupment of fees so that the money would stay in Towpath Focus Fund (i.e. go to our shareholders) instead of going into our pockets.  We are proud to announce that the fund’s expense ratio is now 0.95%, a level at which many far larger funds operate.
​

Mark Oelschlager, CFA  

Oelschlager Investments ​​