Dear Investors,
2024 will go down in history as an absolutely insane year for financial markets. The S&P 500, Nasdaq, and Dow Jones all pushed new all-time-highs, Bitcoin broke above $100k, and all while the treasury market continued its breakdown despite the new cycle of Fed Rate cuts that began in September.
Even with Sonic Capital’s long-biased approach to equities, this has been a particularly brutal year due to the relatively poor performance of less well-known stocks being far overshadowed by the Magnificent Seven that have taken index funds by storm. Interestingly, the top 10 largest companies in the S&P 500 now make up approximately 34% of the index. At the peak of the tech bubble, this same concentration was only 27%.
This, by itself, is not necessarily an indication of a frothy market, but looked at in conjunction with a number of other valuation metrics, it does make us wary about being overweight to the mega cap darlings, along with the now highly concentrated equity indices.
Dismantling the Yield Curve
What has been a surprise to many investors over the last several months has been the massive spike in treasury yields that immediately followed the first Fed rate cut on September 18th. Since then, the yield on the 20-year Bond climbed from 4.1% to 4.9%, and the iShares long-term treasury bond ETF (NASDAQ: TLT) has slid from $100 down to $86 in just a matter of months.
Although this specific ETF tracks government bonds toward the back end of the yield curve, treasuries are generally considered to be near risk-free investments, if held to maturity. Losing the principal could really only occur if the U.S Government defaulted on its debt, which in theory is impossible because of their ability to tax.
However, with the total public debt level in the U.S now exceeding $36 Trillion, many investors on both ends of the political spectrum have been questioning whether or not the government will actually be able to repay these obligations long-term. Hence, why yields on Money Market Securities (maturities of one year or less) have managed to go down while yields on long-term bonds have actually gone up.
One reporter brought this up to Fed Chair Powell in a recent meeting, noting the increase in yields and the massive growth in Government Debt. As Powell noted, the current debt level is sustainable, but the growth rate in debt is not.
As John Adams once said, “There are two ways to conquer and enslave a nation. One is by sword. The other is by debt.”
Still, we cannot underestimate the power of America’s Central Bank and that old saying “Don’t fight the Fed”. There are many indicators pointing towards lower yields in long-term government bonds, and the statements of Mr. Powell and financial journalists simply demonstrate the extreme bearish sentiment in the bond market.
Harris vs. Trump 2024
The November election and Donald Trump’s victory also marked an important event for both the debt and equity markets. Trump’s business-friendly administration and promise of lower taxes sparked further selloff in the Treasury Bond Market at the open on November 5th. The expected decrease in Government tax revenue under the new administration further brought into question the viability of the current debt levels and growth rates, leading to more selling pressure in fixed income instruments and more upward pressure on yields.
And although President Elect Donald Trump is in favor of easing monetary conditions further, the Federal Reserve is designed to operate independently from the Executive Branch of the Government working to achieve its dual mandate of stable inflation and maximum employment. Still, Mr. Powell will most certainly be seeing extreme pressure from the incoming President on interest rates.
Bringing equity valuations into the picture – the S&P 500 is now trading at a P/E Multiple of 29.2x, representing an earnings yield on the index of just 3.43%. Relative to the index’s own history, this valuation is well above the historical average, but backward-looking valuation metrics should not be viewed in a vacuum.
The justification for high P/E multiples in the aggregate is due to the high growth expectations of earnings in the overall market, driven largely by emerging Artificial Intelligence companies that are just beginning to turn profitable.
Still, the question remains, why would investors continue buying equities at an earnings yield of 3.43 percent when they can buy “risk-free” government bonds yielding well in excess of 4 percent? The yield on treasury securities in excess of the earnings yield found in stocks is known as the Earnings Yield Gap. When the yield on government bonds does exceed the earnings yield in stocks, it generally will not hold long-term and indicates one of three things:
- Earnings have to increase, thus increasing the earnings yield in stocks and pushing back above the yield on risk-free government securities
- Stock prices have to go down, thus increasing the earnings yield in equities and pushing the earnings yield back above the yield on government securities
- Bond prices have to go up, thus decreasing bond yields and pushing them back below the earnings yield of stocks in the aggregate
Calling a top in the general stock market is a dangerous game to play. Many tried in the early stages of the tech bubble after seeing many indicators move into overvalued territory, but getting their shorts wiped out as stocks stretched from overvalued to extremely overvalued.
Interestingly though, over the last ten years, there have been three years in which the S&P 500 Index did not tag its 50-Week Moving Average: 2017, 2021, and 2024. Looking back, we know the market was down over 6% in 2018 (following the massive run in 2017) and down almost 20% in 2022 (following the run in 2021). Although economic developments and company-specific earnings expectations are always the long-run drivers of stock market returns, this is noteworthy at the very least.
The Buffett Indicator
Going into the end of the year, we can use the current value of the entire stock market and GDP estimates to plot the Buffett indicator. Remember, this indicator looks at the total value of the market vs. aggregate output and is considered by some macro analysts to be the single best indicator of the relative value of the stock market at any given time.
As of today, the reading on the Buffett Indicator is 2.08, representing a U.S Total stock market cap equal to 208% of GDP. This is sitting 2.2 standard deviations above its historical average, which even exceeds its value at the peak of the tech bubble in the early 2000’s.
Real Estate
As the general market sits in what could very well be considered overvalued territory, there are a few sectors that stand out as promising value plays. Real Estate in particular has taken a beating in the last month, but could be an excellent way to get exposure to a fixed income-like security that does not display the same long-term risk as something like 20-year treasuries.
A diversified pool of REITs, as measured by either the Vanguard Real Estate ETF (VNQ) or the SPDR Real Estate Sector Fund (XLRE), sold off by approximately 13% between December and the first few weeks of January. Looking at the sector as a whole, there are now less than 7 percent of constituent companies trading above their 100-day moving average. Historically, when such a high number of members has dipped below this key moving average, it has served as an excellent buy signal and shows where the sentiment really stands.
As with any investment thesis, precise allocations to the sector are subject to change quickly and may even be removed from the Sonic portfolio altogether if new macro data comes to light. But currently, we see this as an excellent way to take advantage of the expected lowering interest rate environment without taking on completely identical risks to buying and holding long duration Treasury securities.
FOMO
Even with the excellent year for equities, and the Nasdaq 100 returning approximately 29 percent, one group of investors has stood above all others – Cryptocurrency investors. In 2024, Bitcoin shot up from $44,000 per coin to $94,000, although briefly holding above $100k per coin in mid-December. This represents a one-year return of over 100 percent, dwarfing that of the general stock market and only underperforming some of the tech monsters like NVIDIA.
The breakout in Bitcoin came in early November 2024, directly following Trump’s victory in the presidential race. Given his administration’s friendliness toward crypto markets and as a strong believer in Bitcoin, the asset popped from $75k to over $100k in just over a month.
Sometimes referred to as “digital gold”, Bitcoin is also meant to serve as an inflation protection asset, and much of its run prior to the November election was attributed to the hot CPI prints we witnessed in the U.S after the first interest rate cut in September, the same data supposedly responsible for the massive selloff in treasuries.
As central banking skeptics, but strong believers in technology and globalization, Sonic Capital is very open-minded about the future of cryptocurrency, but like any other speculative asset, should be approached with extreme caution. We are happy to ride an upward trend, but it is also dangerous to be overweight in the hot new thing.
As we go into a new year, we have exited some losing positions and added exposure to several new names. We expect a possibility of a correction in the overall market, but find the likelihood of a true bear market to be pretty low, with short exposure to some large names in a risk-defined way, hedged with our beat up value names that are just beginning to show signs of breakouts or the potential for strong upward trends.
Additionally, in a new cutting cycle and with risk-free yields nearing 5 percent, we see a strong likelihood of a rebound in the Treasury Bond Market. This could be perpetuated by simple rebalancing, the finishing of 2024 tax loss harvesting, or a flight to quality in the event of an equity correction. Further selloff in bonds seems unlikely despite the new administration. With the implementation of the Department of Government Efficiency (DOGE), led by entrepreneurs Elon Musk and Vivek Ramaswamy, we may actually witness substantial spending cuts unlike anything we’ve seen for decades. This should subdue fears of long-term defaults on government debt, and although this is by no means a guarantee or assurance, the odds seem in our favor.
Sincerely,
Maxwell Fischer
Investment and Trading Analyst
Sonic Portfolio
Buys:
- Celsius Holdings, Inc (NASDAQ: CELH) – Down over 70% from 2024 high, strong and consistent revenue and trading at low multiples relative to its own history.
- ZIM Integrated Shipping Services Ltd. (NYSE: ZIM) – High dividend payout with moderate consistency, breaking out of long-term base with upside skew potential.
- Unity Software Inc (NYSE: U) – Beaten up tech company that was down over 90% at one point in the short 4-year trading history of the stock. Now up over 50% from the low formed in August, 2024.
- Vanguard Real Estate ETF (NYSE: VNQ) – A way to take advantage of a short-term selloff and the expected lower interest rates coming in 2025
Holds:
- Alibaba Group Holdings (NYSE: BABA) – Exposure to the Chinese market in the form of one of their largest companies. Currently down over 30% from its October high but still seeing higher highs and higher lows after a tumultuous few years for Chinese equities.
- Fastly, Inc (NYSE: FSLY) – IT services company that was down over 95% from all-time-high. Increasing revenue and breaking into upward trend.
- MARA Holdings, Inc (NASDAQ: MARA) – Bitcoin mining company with substantial cryptocurrency treasury. A way to get exposure to the market without having to store coins or digital assets in a separate wallet.
- Albemarle Corporation (NYSE: ALB) – Lithium company with strong revenue and healthy balance sheet. Down over 75% at one point, but high upside skew potential.
Exits:
- Canopy Growth Corporation (NASDAQ: CGC) – peaked in April 2024, and straight down since. Legalization in Florida was not passed during the November election and there have been no signs of life in this stock, moving from almost $15 per share to less than $3 in the second half of the year. Possibility of futures spikes but needs to see some catalyst before it is worth touching.
- MEDIFAST INC (NYSE: MED) – despite the 90+ percent selloff over the last few years, and the relatively solid value characteristics, there seems to be no catalyst supporting Medifast in the long run, although it does display some upward skew potential, there will have to be signs of life before any long position is re-initiated.
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