MONTHLY MARKET MUSINGS

January 2025

Looking Ahead To A New Year

Following two back-to-back strong years for equities, it is not surprising that some of the market rhetoric has become skeptical if not outright negative when it comes to what's in store for 2025.

Valuation of the equity market has been a point of concern for many. So, are equities overvalued? We would say that while they are not exactly cheap, they are also not as extended as many of the headlines claim they are. The reason behind this, in our view, is that there are supportive earnings growth underpinning share prices. Typically, when equities are deemed overvalued, it is usually a reference to the current forward price-to-earnings (P/E) multiple, which is the ratio of the stock price to the consensus earnings estimates for the upcoming 12 months. This is then compared to the long-term average forward P/E multiple. The issue here is that the structure of the broad market has experienced a drastic change over the past two decades as technology, a high growth sector, has emerged to become by far the largest component of the broad U.S. market. Now, with the largest tech stocks accounting for significant portion of the S&P 500 index, the average, at least theoretically, should be skewed higher given that the largely weighted tech stocks have higher multiples associated to them. Therefore, we can surmise that the long-term historical average is likely lower than it should be given the current market structure and that it will be pulled higher going forward.  

Another point of concern that has been making headlines is the cash level of Warren Buffet[1] which has increased quite a bit over the course of 2024. To start, it is worth mentioning that Mr. Buffet does not time the markets and it has never been part of his investment strategy. Therefore, drawing any conclusions that he is attempting to time a correction in the market based on his cash levels is likely without merit[2]. There are a few possible reasons as to why his cash level has increased. One explanation could be due to his large position in Apple having been trimmed and there being a lack of investment options at this time that fit the criteria of his specific methodology. This would suggest that Buffet will take his time and deploy his capital prudently as he sees value in the limited investable universe he has. Berkshire does, arguably, have a limited investable universe and the reason for that is due to the size of their asset base. Essentially, for an investment to have a real impact on their portfolio's overall return, Berkshire needs to have a sizable position which means several billion dollars in shares. This constrains the number of companies that are investable for them given that buying several billion dollars of shares in many companies would mean buying a large or even majority stake in the company. Given this, their investable universe narrows to mostly large and mega-cap names. As for the selling of Apple share specifically, many media outlets have pointed to this as a sign that Buffett has become bearish on the stock and the market in general. In reality, Berkshire's position in Apple had grown to about 45% of his public equity holdings in early 2024[3] and the decision to trim it down to about 20-25% was taken. It was likely more of a rebalancing of an overweight position to lower the overall concentration of risk his investment portfolio was exposed to rather than an expression of a negative view on the stock. Even with the sale of the shares, Apple remains Berkshire's largest public equity holding[4]. To be clear, Berkshire Hathaway also holds private investments therefore while the Apple holding made up 45% of its public equity holdings, it was likely less than 30% of total assets once the private side of the business is considered. Following the trimming this position, Berkshire found themselves sitting on the excess cash. As noted above, we have experienced a significant change in the market dynamic over the past 10-20 years with technology being a major component of the overall broad market composition now. Furthermore, it is well known that Buffett does not invest much in technology and that Apple has been his main exposure to that sector. Thus, if we have a market that skews towards tech and growth names, it is not very surprising that one of the largest value investors in the world, who underweights technology, may have to take some time and be strategic when trying to find areas to deploy his large amount of funds.

As we consider the economy heading into 2025, we believe that the signs are still pointing to a relatively decent year. At this stage, the U.S. seems to be in a better position economically than Canada. As we have discussed before the tariff situation is uncertain, but we generally do not think Canada will end up being the main target of those U.S. policies. Investors should also look at the key messaging that has been provided by the central banks of both countries when trying to gauge how the economy is progressing. The U.S. Federal Reserve bank (Fed) has signaled that it will pause its rate cuts for the early part of 2025[5]. If the Fed was concerned with the potential for a slowing economy, it is unlikely that they would be pulling back on monetary easing. They would instead be executing larger and more frequent rate cuts. The Bank of Canada has not quite said they plan to pause rate cuts any time soon. They did, however, note that the pace would be more gradual which essentially means that aggressive cuts are no longer needed at this stage[6]. These changes in the pace of their monetary policy actions should be viewed as a sign of confidence in the broader economy. With the economies being in a good spot and stocks still moving in lockstep with earnings growth, we continue to maintain a positive view on equities in the new year.  

JAY SMITH, CIM®, FCSI

Senior Portfolio Manager & Senior Wealth Advisor    

jay.smith@cibc.ca

BRAD BROWN, MBA, CFA
Portfolio Manager & Associate Investment Advisor

brad.brown@cibc.com