Current Market Volatility Normal for a Bull Market
The S&P 500 is off to a bit of a rocky start in 2025, an extension of weakness in December 2024. We are already getting questions about whether it’s time to panic, with bearish narratives starting to come out of hibernation across social media. While there are reasons for recent declines, we view it in part as a perfectly normal pause after the gains of 2023 and 2024. In fact, one of the reasons for last week’s 1.9% decline is that we had a strong jobs report Friday. Market participants seemed to worry it was too good, the S&P 500 selling off 1.5% on Friday alone. Good news can be bad news in the short run, but a solid economy usually becomes good news again once we get past the initial market reaction.
One of our favorite charts shows the historical frequency of different levels of S&P 500 declines in an average calendar year. Declines of 3% are garden variety. We average 7.2 of those a year, which means that we’re more likely than not to see one in any given month. A mild correction of 5% or more occurs a little more than three times a year. We’re not even there yet, even if we go back to the S&P 500’s December 2024 highs. There are always narratives around declines that makes it seem like they’ll become more extended, but if part of what’s driving the declines is good news, we would be careful about getting too caught up in them.
For now our verdict is that recent declines are due to heightened market sensitivity to the news cycle following a strong run. If the underlying economy is sound, pullbacks like this can actually be a positive for the longer-term health of the market.
US Market Concentration Not That Unusual
Market concentration on the top of the S&P 500 Index has been getting a lot of attention. Index concentration is at a record high. The top 10 names in the index currently make up 38.8% of the total weight. According to data from Ned Davis Research, this isn’t that far off from the early 1970s, when index concentration peaked at around 34%, a level not reached again until the middle of last year.
Back then a technology name was also the largest in market cap — IBM, the dominant manufacturer of mainframe computers. IBM had the highest market cap for most of 1965 – 1988, as its mainframe dominance turned into PC dominance. It was an extraordinary run, but nothing lasts forever.
Bell Systems, the second largest company, was also in many ways a technology play. After all, the telephone system and the infrastructure required for it was the internet of its day. In addition, the research required to build the infrastructure for global telecommunications made Bell Systems one of the greatest innovators of the 20th century.
Also in the top 10 in the early 70s, several oil companies, Eastman Kodak, and General Motors. The last two highlight the challenges of keeping up with changing markets and technology, as GM declared bankruptcy in 2009 and Kodak in 2012.
While current US market concentration is high historically, it’s not if you compare the US to other countries. We looked at the holdings in ETFs that track MSCI country indexes across the 20 largest markets outside the US in developed and emerging markets. Of those 20, US concentration levels are lower than all but two of them (Japan and India). The average concentration in the top 10 names across these 20 other countries is 58%, and the median is 61%, well above the US. And it’s similar whether you look at developed or emerging markets. In fact, in a lot of countries, financials tend to make up a larger portion of the index, making them much more cyclical than the US.
At the same time, if you diversify broadly across the rest of the world, the top 10 weight collapses to 18% (using the MSCI ACWI ex US Index as a proxy). There are a lot of opportunities to diversify portfolios so they aren’t as concentrated as the S&P 500. Those companies at the top of the S&P 500 have been dominant, however, because many investors have chosen not to diversify away from them, in part due to the earnings power they have exhibited. But some of those companies will become an IBM, GM, or Kodak — perhaps still worthy of investment in the future, but not the dominant player it is today.
The Labor Market Is Solid (for Now), But Is Good News Bad News?
There have been a few signs that risks to the labor market are tilted to the downside, but the December payroll report went a long way towards easing them. The economy created 256,000 jobs in December, blowing past expectations for a 165,000 increase. Monthly numbers can be noisy and so a 3-month average is helpful. That’s running at a solid 170,000 per month, versus an average of 166,000 in 2019. The economy created over 2 million jobs in 2024, down from 2.4 million in 2023 but well in the ballpark of what we saw in 2017-2019 (2.1 million average per year).
Also good news was the unemployment rate falling from 4.2% to 4.1%. That’s up from 3.7% a year ago, but we’re off the summer scare when the unemployment rate picked up to almost 4.3%. The prime-age (25-54) employment-population ratio, which is a way of controlling for demographic effects and labor force participation issues, is 80.5% — exactly where it was a year ago, and higher than at any point between May 2001 and December 2019.
If the labor market stabilizes here, that’s a pretty good place. There are still some concerns though. Overall hiring has slowed a lot. The hiring rate, which is the number of hires as a percent of the labor force, has fallen to 3.3%, the slowest pace since 2013 (outside of the Covid months). But net hiring (which is what comes out of the payroll report) is still strong because separations are low. Workers are quitting their jobs less frequently. The quit rate has fallen to 1.9%, versus 2.3% in 2018-2019. By no means is a 1.9% quit rate a bad level but it’s the trend that’s concerning. It tells you that workers are wary of quitting their jobs because it’s probably hard to find another one that’s better.
Separations are also low because layoffs are running low, around 1.77 million versus1.8 – 1.9 million before the pandemic. But the labor force is also larger now. The layoff rate (layoffs as a percent of the workforce) is at 1.1% (versus 1.2-1.3% in 2018-2019). Companies clearly want to hold on to their workers, who have also become a lot more productive at their jobs. But they’re more judicious about hiring.
The big picture is that the labor market is in a solid place and it looks to be stabilizing.
But Wait, Is Good News Bad News?
The December payroll report was broadly positive from several angles. However, investors weren’t too happy. The interest rate on 10-year Treasury notes jumped from 4.68% to about 4.75% and the S&P 500 pulled back by over 1.5% (and the small cap index, the Russell 2000, was off almost 2%). It’s typically not useful to read too much into market moves, especially short-term ones, but the immediate reaction is interesting and worth going into.
Interest rates are higher because the market likely thinks stronger job creation, and a stronger economy, will put more upward pressure on inflation, which means the Federal Reserve (Fed) will have to pause on rate cuts. Cue expectations for rate cuts in 2025, which moved significantly after the payroll report was released. Markets are now expecting just one rate cut in 2025 (with a probability of under 25% for a second one) and don’t expect it to happen before June. The 2025 policy rate is expected to be about 4.1% (currently at 4.4%). And markets don’t expect the Fed to cut any more after that. Long-term policy rate expectations have climbed to 4.4% (based on the expected 2029 policy rate). All of which largely explains why longer-term interest rates have surged as much as they have. As you can see, policy rate expectations have been creeping up since last summer, mostly as the labor market data has come in better than expected (along with other economic data).
Now, we wouldn’t put too much stock into what markets are pricing in by way of rate cuts. A year ago today, markets priced in seven cuts (1.7%-points total) for 2024, and then shifted it to just one cut by summer (0.25%-points), before setting on 4 cuts by year-end (1.0%-point, which is what we got). Things can shift, by a lot.
We do think we may be sitting on our hands waiting for the Fed to cut rates once again, even though we believe we’re likely to see the Fed cut 2-3 times in 2025. Ultimately, it comes down to the inflation picture. We’ve discussed frequently the issues with lagged components of inflation data (like shelter, but also things like rising stock prices). Yet, the forward-looking picture still suggests inflation is running close to 2%. We got more data pointing to this in the December payroll report. Over the last three months, wage growth for private sector workers is running at a 4.1% annualized pace, and for production and non-supervisory workers (non-managers, who tend to spend more of their income), it’s at 3.5%. These are strong levels and suggest consumer spending should remain strong. But they’re also very close to what we saw pre-pandemic, telling us there aren’t any demand-side inflationary pressures in the economy.
Hopefully Nothing Breaks While We Wait for the Fed
While we wait for rate cuts, the hope is weakness in rate-sensitive parts of the economy doesn’t creep into other areas. Housing is really the key here. Mortgage rates are running around 7.3% right now, and at that level, it’s tough times for housing. Mortgage applications and refinancings are down 20% from November, and the latter are down 65% from September. If mortgage rates stay elevated into the spring home-buying season, that’s a potential drag on the economy. For now, the only relief is that housing weakness has not crept into construction employment. It was strong even in 2022 and 2023, which was another clue that a recession wasn’t imminent. Historically, construction employment has foreshadowed further weakness across the labor market (and recessions), which makes sense because elevated interest rates (and tight monetary policy) has preceded past recessions. If housing remains weak due to elevated rates, we could see construction employment start to pull back. For now, construction employment is rising at a 2.4% year-over-year pace — still healthy, especially relative to the 1.8% increase in 2019, but the current pace is down from 3% a year ago. The downward trend is something we’ll be keeping a close eye on for the next several months.
This newsletter was written and produced by CWM, LLC. Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. The views stated in this letter are not necessarily the opinion of any other named entity and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.
S&P 500 – A capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
The NASDAQ 100 Index is a stock index of the 100 largest companies by market capitalization traded on NASDAQ Stock Market. The NASDAQ 100 Index includes publicly-traded companies from most sectors in the global economy, the major exception being financial services.
A diversified portfolio does not assure a profit or protect against loss in a declining market.
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