The Power of Staying Invested During Uncertain Circumstances
Many recent client conversations have revolved around the various uncertainties that exist in today’s environment. From anxiety-inducing geopolitical events to wild currency swings to societal disruptions, there is no shortage of items to worry about. While we agree there is a heightened element of risk in global financial markets, that does not mean there is a dearth of opportunities.
At Wolf Group Capital Advisors, one of our core portfolio management philosophies is balance. We are not so permanently bullish that we do not see risks and are always 100% invested in growth equities nor do we want to be so aware of all the numerous threats that we are paralyzed with inaction sitting in cash.
Regardless of which side of the aisle you are on, there has been a whirlwind of polarizing political emotion over the past several years. Since 2016, we’ve heard the term “threat to democracy” more often than any of us would have liked. We also now know that regardless of which party has been in power, the broad US stock market has done extraordinarily well since March of 2009.
As investment managers with a focus on asset allocation, our general concerns around investment returns are not concentrated on the existential risks that some may see if the political party opposing their views gains power (whether in the most recent election or the election previous to that). Our concerns are more focused on particular areas of the market becoming overvalued and on prevailing market sentiment changing due to something unforeseen.
For instance, investors are currently willing to pay approximately $22 for every future dollar of earnings in the basket of S&P 500 stocks. How long will that relatively high multiple last? Perhaps something occurs (whether it be geopolitical, a Fed Policy mistake, a global health scare, or something we haven’t yet fathomed) where investors collectively say, “I am no longer willing to pay a premium amount per dollar of earnings. Because of all the unknowns and all the risks, I am now only willing to pay $15 per dollar of earnings across the basket of S&P 500 companies.” This is, albeit an oversimplification, investor sentiment/psychology in a nutshell.
Investor psychology is inherently difficult to predict and something that drives markets more than many market fundamentalists would like to admit. To paraphrase Warren Buffett, in his ever-lasting wisdom—sometimes no one is worried about risk and other times everyone is worried about risk. The issue is, despite the simplicity of Buffett’s statement, accurately predicting when the collective investor sentiment will shift is nearly impossible.
Because of the extraordinary difficulty of predicting human behavior, most professional investors focus on the fundamentals of individual companies (earnings, cash flows, etc.) and the fundamentals of broad markets to assess attractive investment opportunities. When focusing on the current, existing market fundamentals, the landscape actually does look more stable than one would expect given what they may be reading in their daily periodical of choice.
As we look out into the horizon of 2025, there are plenty of reasons to be optimistic and, as usual, reasons to remain cautious. On the side of optimism stands an economy that is still expanding with a growth rate north of 3%, an unemployment rate around 4.2% and inflation that has been tamed to below 3%. Corporate earnings also continue to be strong with expanding margins and revenue growth. However, reasons to be cautious abound as well with many pundits forecasting that current market valuations are stretched and pointing out that index concentration levels (the top 10 stocks of the S&P 500 now represent approximately 38% of the index) are moving dangerously higher.
Despite these concerns, we see many attractive areas across asset classes. As 10-year treasury rates climb, value-oriented equities tend to come into favor; this is one reason we have a slight value tilt in many of our client portfolios. Further, the long-term average forward P/E multiples of value to growth are 0.71 (that is, 15.0 to 21.1). They currently stand at 0.56 (i.e., 16.2 to 28.9) which also would suggest that value-oriented equities are more compelling in the current environment. In terms of expected earnings growth rates for 2025, small cap and mid cap companies are expected to surpass large cap companies. Because of this, Wolf Group Capital clients will also likely see a shift toward smaller capitalization companies in their portfolios at various points this year.
In the fixed income arena, opportunities are beginning to come into focus as yields increased throughout 2024. We see attractive opportunities not just in short-term fixed income but also further out along the yield curve as rates approach 5%.
More than a few clients have expressed their surprise to hear that we are not averse to taking calculated risks in our portfolios. I should point out, that many of these same clients were surprised to hear this in both 2023 and 2024. With the benefit of hindsight, we now know that risk-taking was rewarded handsomely in those two years. Anyhow, there are numerous reasons why we continue to see owning equities in one’s portfolio as appropriate. Three of the primary reasons why we believe this market (and economy) has staying power are that the consumer is still doing really well, corporations are still healthy, and a pro-growth policy mindset exists.
The above is not to say we believe the overall environment is sanguine and there are no risks. We do see a number of potential risks and do not want to discount them. For example, in the large growth area of the US market, it can be easily argued that valuations are rich and the momentum trade is overcrowded. As Howard Marks wrote in a recent memo, “it shouldn’t come as a surprise that the return on an investment is significantly a function of the price paid for it. For that reason, investors clearly shouldn’t be indifferent to today’s market valuation.”
A colleague we recently spoke with that works at a large investment firm informed us that their investment flow data has shown that 64% of all capital that got invested in 2024 was deployed into the large growth US equity asset class. This helps to explain the second straight year of meteoric rise in the “Magnificent 7” stocks as well as the fact that these same names can suffer dramatic setbacks due to something as innocuous as the DeepSeek AI model news that came to light in early February. If markets were more efficient, that news would not have caused such a massive selloff in numerous large cap technology companies. So, while we believe it still prudent to have risk in one’s portfolio, we also believe it wise to diversify as risks are skewed to the downside in various areas of the market.
In summary, we believe the positives throughout the year will outweigh the negatives and that asset classes other than large cap US equity should be appealing to investors in 2025. Because of this, we assign a high probability to 2025 being a year in which a diversified portfolio proves to be effective relative to recent years. When the calendar turns to 2026, we feel strongly that investors will be thankful that they owned bonds, international equities and alternative assets throughout 2025 as these out-of-favor assets will have benefitted their long-term returns.
Sincerely,
Chief Investment Officer
About Wolf Group Capital Advisors
At Wolf Group Capital Advisors, a comprehensive wealth management firm and Registered Investment Advisor (RIA) based in the Washington, D.C. metropolitan area, nothing is more important than the fiduciary responsibility we have in managing your wealth. Taking the utmost care, we focus on providing advice tailored to your specific circumstances. With more than two decades advising U.S. expatriates and non-US citizens employed by international organizations, we are qualified in investment strategies addressing global issues. Empathy and curiosity—combined with our experience in life planning and investment management—enable you to explore a wider set of possibilities that can lead to a fulfilling life you’ve worked hard to attain.
Disclosure:
The views expressed represent the opinions of Wolf Group Capital Advisors as of the date noted and are subject to change. These views are not intended as a forecast, a guarantee of future results, investment recommendation, or an offer to buy or sell any securities. The information provided is of a general nature and should not be construed as investment advice or to provide any investment, tax, financial or legal advice or service to any person. The information contained has been compiled from sources deemed reliable, yet accuracy is not guaranteed.
Diversification and asset allocation do not ensure a profit or guarantee against loss.
The information presented is not an offer or a solicitation to buy or sell securities. The information contained in this presentation has been compiled from third-party sources and is believed to be reliable; however, its accuracy is not guaranteed and should not be relied upon in any way whatsoever. This presentation may not be construed as investment, tax or legal advice and does not give investment recommendations. Any opinion included in this report constitutes our judgment as of the date of this report and is subject to change without notice.
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