The Stock Market Is Historically Pricey: Here's How I'm Positioning My Portfolio for 2025

When things seem too good to be true on Wall Street, they usually are.

As we approach the end of another impressive year on Wall Street, major indices like the Dow Jones Industrial Average, S&P 500, and Nasdaq Composite have recorded remarkable gains. As of mid-December, the Dow had increased by 12%, the S&P 500 by 23%, and the Nasdaq by 29%. These returns far exceed the average annual performance of the stock market.

However, this surge raises concerns since, historically, when such situations arise, they often precede a downturn.

The stock market’s high valuations indicate caution

For over a year, several signs have indicated potential difficulties ahead for both the stock market and the broader U.S. economy. These warning signals include a decline in the U.S. M2 money supply, an unprecedented period of yield-curve inversion, and the historical connection between Federal Reserve rate changes and stock performance.

One notable indicator is the Shiller price-to-earnings (P/E) ratio for the S&P 500, also known as the cyclically adjusted P/E ratio (CAPE Ratio). This metric offers a long-term perspective on market valuations by averaging inflation-adjusted earnings from the past decade.

As of December 18, the Shiller P/E was around 39, significantly higher than its historic average of approximately 17.19 since 1871. This pattern of elevated valuations, observed more frequently over the last 30 years, can lead to unsustainable market conditions, reminding us that prices eventually correct.

My strategy for a potentially challenging 2025

As a seasoned investor, I have experienced several market cycles where the Shiller P/E surpassed 30. Based on my experiences, I follow a five-point strategy in preparation for a market that may be marked by volatility:

1. Stick with core holdings: Historically, downturns are short-lived, with most bear markets concluding in less than a year. Therefore, I maintain my core investments which I have held for several years.

2. Look for value stocks: During times of market uncertainty, investors often gravitate towards value stocks. While finding value can be challenging, companies like Pfizer, which have experienced significant pullbacks, might offer attractive buying opportunities.

3. Focus on dividend stocks: In a pricey market environment, I concentrate on building my portfolio with dividend-paying stocks. These provide a reliable income and can help cushion against market fluctuations.

4. Sell underperforming stocks: If a stock no longer aligns with my investment thesis, it may be time to divest. For example, I moved away from Teledoc Health due to increasing competition and the company's unsustainable spending practices.

5. Keep cash available: Having cash reserves allows me to take advantage of buying opportunities that arise during market corrections. I generally aim to maintain 15% to 30% of my portfolio in cash during high valuation periods.

The market appears poised for challenges ahead, and those who are prepared can navigate potential downturns effectively. Staying informed and adapting to changing conditions will be essential as we head into 2025.

Stocks, Valuation, Investment