Investors in their early years are wired to look for maximum absolute returns. With a long runway to retirement, it’s all about creating the largest nest egg possible so that lifestyle aspirations can be achieved. As the runway shortens, it’s not that growth objectives disappear but the focus shifts to maximizing risk-adjusted returns. In other words, achieving some growth with stricter parameters around risk factor exposures, the barometer of both return and risk is volatility. Considering how much uncertainty is bearing down on markets today, one would think that we would be working very hard to get little in the way of gains. In fact, it has been the opposite in recent weeks.

At the time of writing, the Dow Jones was off 0.8% on the day and week, while the S&P500 was posting a decline of 0.5% and the TSX was off 0.6%.   Much of this late-week deterioration stemmed from a weaker than expected University of Michigan consumer sentiment index (64.7 versus consensus of 67.8), which reinforced the cautious tone in Walmart’s latest results. S&P Global also released its U.S. Flash Composite PMI Output index, which showed a drop to 50.4 in February from 52.7 in January – the lowest it has been since September 2023. Businesses reported concerns about political uncertainty flowing out of the White House, spending cuts and geopolitical issues, all feeding into a less robust sales outlook.

The recent slippage in equities still leaves us with relatively decent performance since the start of the year and just this week, the S&P hit a new record high as seen in the chart above. On a year-to-date basis, the index is up 3.3%, compared to a 2.9% lift in the Dow and a 2.5% rise in the TSX. This performance has come without the help of the so-called “mag 7”, which are collectively down 1.3%.

As of February 20, 2025, the S&P 500 boasted a price-to-earnings (P/E) ratio of 27.43, surpassing its 10-year average of 18.56. In terms of sectors, the information technology group is trading at a P/E of 38.4 – well above its 10-year average of 22.6, health care is trading at a P/E of 32 versus a 10-year average of 19.9, and even consumer discretionary posts a P/E of 28.9 – more than 5 points above its 10-year average. The only major group trading close to its average P/E is energy, at 15.

These valuations still reflect improved margins over recent quarters, but the assumption of continued growth is put in question by policy uncertainty and what happens to input prices should tariffs get implemented in the coming weeks. In other words, if earnings growth predicted by where the market is trading is not achieved, then valuations could start to look stretched.

Still, despite this uncertainty, actual market volatility isn’t behaving like one would expect. Today, the CBOE VIX index edged up above 16 on an intraday basis after closing last week below 15. Compared to early December, these levels are elevated but a far cry from the high at the start of the month, and especially the peak seen in January above 19. Surprisingly, we have seen historical 10-day volatility for the TSX slip back this week, again to levels well below their peak towards the end of last year.

Now that we are past the Trump honeymoon phase, it is natural to see volatility push higher as he enacts policy, even if what is coming out of the pipe is more subdued than what he promised. If that changes, then we would look for volatility to climb back to levels that we saw in 2024. That is important for investors who are more concerned about risk-adjusted returns versus just the results on the last statement. If we look at 2023 and 2024 side by side in terms of what the S&P delivered, there isn’t much difference. However, if you consider that volatility trended lower over the course of 2023, while 2024 had sporadic spikes, then the risk-adjusted performance in 2023 looks better.

In speaking with clients in recent weeks there is a common message of caution. While indexes continue to press higher and volatility is tame, there is an expectation that one or both of these factors could leave us. Based on the S&P output index, companies are dealing with the same set of mixed emotions. The economy looks okay today, and consumers are still spending, but it’s the cloud of uncertainty ahead that has some hedging their bets. The same holds true for one’s portfolio. While it still makes sense to be close to your allocation strategy, building in some defense is prudent, whether in trimming back exposure to excessively high valuation stocks or building up exposure to less correlated securities such as liquid alternatives.

On behalf of the Pyle Wealth Advisory team, have a wonderful weekend.   

Andrew Pyle