01 Jan Opportunities in 2025 – 2025 Q1 Commentary

We thank you for being a client of Morris & Wells during 2024. The year had a number of twists and turns in the portfolio and the market, and we appreciate your support and trust in our fiduciary care. For the first time in two years, we will not make a big announcement within our first quarter newsletter. We re-branded the firm in 2023 and announced Charlie King’s retirement last year. This year we will review 2024 and cover some out of consensus thoughts for 2025.

At the beginning of 2024, we shared that if cybersecurity companies did well in the stock market during the year and energy stocks also did well, the portfolio would likely perform well. Despite a slow start to 2024, cybersecurity stocks did pick up steam and showed strong gains for the year. As we described on our Halloween webinar, energy stocks had not participated in the gains of 2024, nor did they tick up following the webinar. The market seems to believe we are oversupplied with oil at the moment. There may be a high supply today, but demand looks temporarily reduced. Furthermore, we believe that each of our energy holdings operates more efficiently than in the past. These companies continue to show strong profitability at today’s oil price levels. The one year forward price-to-earnings ratio of the three investments we own in the energy exploration, production, and services segments amount to 10.7x, 10.1x, and 10.3x. The respective forward dividend yields amount to 5.4%, 3.3%, and 2.9%. With that back drop, we move into 2025 still invested in this sector as the S&P 500 is trading closer to a 23x one year forward price-to-earnings multiple.

Graph 1 illustrates that the large technology stocks led the market during 2024. In fact, the top eight technology companies increased their market capitalization (calculated by shares outstanding multiplied by price per share) by 70% more than the other 492 stocks in the S&P 500 combined. We do not invest your money and our money with the goal of being contrary to the S&P 500 – we owned one of the aforementioned companies during 2024. However, we do think that a collection of companies growing their earnings and with valuation profiles more like the energy companies we discussed above, give our portfolio a better chance at future outperformance.

As noted, the one year forward price-to-earnings multiple on the S&P 500 amounts to about 23x as of the time of writing. Meanwhile, the Value Line 1700 (1700 largest US companies equally weighted), our preferred measure of the “average stock’s” performance, has increased 3.3% year-to-date 2024. That means a majority of individual stocks in the Value Line did not perform well during 2024. Therefore, we see a number of opportunities ahead. At the time of writing, either because of valuation, market position, operational excellence, or some combination of the three, we see no less than five investments in the portfolio that either a financial buyer or strategic buyer could actively pursue during the new year.

Part of our excitement for the investments we have discussed as undervalued comes from our view that the US consumer still finds him/herself in strong financial shape. The consumer has become a key contributor to US Gross Domestic Product (GDP) as you can see in Graph 2 below. That figure even ticked up after Covid. Currently, financially healthy consumers provide a strong tailwind for the US economy. Evidence to support this view comes from Graph 3 below, which shows despite a rising interestrate environment since the end of 2022, the US consumer continued to purchase automobiles, as measured by SAAR (seasonally adjusted annual rate). That measure climbed back to almost pre-Covid highs. With unemployment remaining low and the consumer confidence high, we remain optimistic about the US economy as we move into 2025. We see a pathway for even more growth and optimism. Some US industries find themselves at cyclical lows as companies work through oversupply following Covid and begin to receive new orders – especially in the data center and infrastructure area.

Out of Consensus Thoughts and More for 2025

At this time of year, many market pundits publish their forecasts for the following year. Forecasts include some outlandish predictions and ideas not in the financial media consensus. We would like to humbly offer five scenarios that we think are out of consensus today, but we leave room in our minds for the small possibility of one or more of these scenarios coming to fruition. These ideas are not meant to be “stunners,” but realistic scenarios.

2025’s Thoughts

1. One geopolitical event temporarily roils markets – possibilities include Russian/Ukraine, the Middle East, China/Taiwan, European recession. This volatility will provide a possible buying opportunity.

2. The Federal Reserve makes one cut to the Federal Funds Rate range. Once at 4.00%-4.25%, the Fed sees signs of stubborn inflation and holds rates steady for the remainder of 2025.

3. The market sees some of the new Department of Government Efficiency’s proposals as beneficial, and that optimism extends to the general stock market.

4. The Artificial Intelligence (AI) and datacenter build out continues globally, but investors and the supply chain get reminded about the cyclicality of technology buildouts. That reminder may serve as a buying opportunity in the related stocks.

5. The unintended consequences of initiating additional tariffs – e.g., inflation – lead to the outperformance of a market sector not directly tied to the eight companies that drove the S&P 500 during 2024.

The year 2024 provided several market and portfolio moving events. We had to adjust to those. In order to move forward, we kept to our true north, which means investing in strong companies, purchased at reasonable valuations. We are sure 2025 will bring a similar number of market moving events. We will see which, if any, of the out of consensus thoughts above come to fruition, and how to best navigate any surprises. If you have short-term (meaning zero to 18 months) cash flow needs that we have not discussed, please reach out. We want to prepare for those needs with you and ensure your portfolio is positioned to cover your outflows of cash. 

If you have any questions about the above or anything else, please contact us. We love to chat with you. Thank you for your trust and ongoing support. Have a great 2025!