Given the S&P 500's dramatic run-up over the past two years, it may be hard to remember, but, in December 2022, many expected stocks to stumble.
As a result, the S&P 500's back-to-back 20% plus gains in 2023 and 2024 caught many Wall Street analysts flat-footed, sending them scrambling to ramp forecasts and outlooks.
While they were left chasing, proving once again that most Wall Street analysts are late to the party, hedge fund manager Doug Kass wasn't shocked by the stock market's impressive move higher.
Kass, who has navigated the markets professionally for over 40 years, told investors in December 2022 to expect double-digit returns through the first six months of 2023.
It wasn't the first time Kass has delivered such a prescient prediction. In December 2021, he accurately predicted the S&P 500 would stall in 2022 following an early-year high. He also correctly predicted that inflation would increase to 8%, forcing the Fed to give up its dovish monetary policy in favor of rate hikes.
More recently, he correctly said in December that Nvidia (NVDA) would struggle after its record-setting run. So far, that's been spot on, given Nvidia's shares are down about 10% since their 153.13 intraday peak on Jan. 6.
Of course, not everyone is right, including Kass. Still, his track record managing money professionally, including as Director of Research for Leon Cooperman's Omega Advisors, and his particularly accurate past calls suggest investors should pay attention to what he's saying about the S&P 500 now.
Hedge fund manager Doug Kass recently offered up a new prediction for the S&P 500.TheStreet
The stock market hits a headwind
In 2024, the S&P 500's rally was built on the back of a seismic shift in interest rate policy. Following sky-high inflation in 2022, the Federal Reserve had ratcheted higher its Fed Funds Rate, causing borrowing rates to surge to slow economic activity and wrestle inflation lower.
While inflation has yet to achieve the Fed's target of 2%, it has made pretty remarkable progress toward it, sinking below 3% in mid-2024.
The inflation-rate decline and pressure on the economy caused by higher interest rates led Fed Chairman Jerome Powell to switch gears from battling inflation to protecting against unemployment.
As a result, the Fed began cutting interest rates, sparking investors' optimism that lower borrowing costs would allow companies to plow big money into new growth projects and pad their bottom lines by lowering variable debt costs.
The S&P 500's 24% gain in 2024 was also fueled by an artificial intelligence gold rush. After OpenAI's successful launch of ChatGPT (the fastest app to reach 1 million users at the time), companies began throwing cash wildly at IT budgets to train large language models and create agentic AI software programs for businesses.
As a result, hyperscalers like Microsoft's Azure (MSFT) , Alphabet's Google (GOOGL) , and Amazon's (AMZN) AWS plowed big money into AI infrastructure, like servers and Nvidia's pricey H200 semiconductor chips. In 2024, those three companies spent nearly $200 billion on the stuff necessary to build their businesses.
Now, however, the situation may be changing.
Yes, big tech is still spending a ton on AI, but there's growing concern that IT budgets are about to hit a wall. One reason? The Fed is no longer worried about unemployment much, given it is still relatively low, still near 4%. But it is getting nervous about inflation, which has picked up again since the fall.
As a result, odds of more Fed interest-rate cuts have plummeted, causing yields to increase. Oh, and it doesn't help big tech that the U.S. dollar has also strengthened because of the rate cut uncertainty, pressuring sales overseas.
Fund manager offers a dire S&P 500 warning
Stocks follow earnings over time, and earnings grow fastest when rates are falling, not rising.
That doesn't bode well for the stock market or the S&P 500 benchmark index, especially given that the rally over the past two years has arguably pushed valuation to sky-high levels.
The S&P 500's forward price to earnings ratio, a key measure of valuation, is 22.2, according to FactSet's number crunchers. That's significantly above the 5-year and 10-year average P/E's of 19.8 and 18.3, respectively.
In short, stocks aren't the bargain they were back at the end of 2022. A lot may need to go right for them to deliver yet more gains without the help of rate cuts or ramping business spending.
That's got Kass nervous.
"Going into this year, I believed the S&P's 2025 upside was about +5% (not intended to be precise!), and the downside was between -10% and -15%," said Kass in a post in his diary on TheStreet Pro on Friday. "The move towards the higher end of my year's forecast earlier this week substantially eroded the reward/risk ratio (even further) to virtually zero upside and 15%+ downside."
That's not a great recipe for risk-takers. Kass thinks January will mark the year's high, particularly for the so-called magnificent seven tech stocks.
"With "slugflation" ahead (prickly inflation and sluggish economic growth), fixed-income markets providing a near equity-like return (with less volatility and risk), fiscal and monetary policy unpredictable (and, perhaps wrong-footed), valuations above the 96%-tile and market structure being a bonafide concern (with most on the same side of the long boat), equities remain overpriced," added Kass.
So what's an investor to do? Certainly, long-term investors shouldn't make dramatic changes. After all, stocks go up over time, but they do go down along the way. However, active investors, or investors who have borrowed money on margin to buy stocks, may want to think hard about their goals. After all, risk can be dumb, as billionaire 5-hour energy founder Manoj Bhargava recently pointed out.
As for Kass? He's not taking chances.
"In late January, my hedge fund began to liquify, taking off a number of longs and pairs trade in anticipation of a buying opportunity in the coming months," said Kass.
