TURN THE PAGE: HELLO 2024!
We will start with an executive summary of economic and market factors we think are important as we gauge the chances for another good year in stocks in 2024:
DOMINANT THEMES: Inflation, the Fed, and artificial intelligence (AI) were the three prominent themes in 2023. This year we expect the market to focus on a soft landing, interest rates cuts (when and how many), geopolitical risk and AI.
MARKET CYCLES: The S&P 500’s gain during the current bull market has been relatively weak. The consensus by investors seems to be we are in the latter stages of the bull. We disagree. We think we are in the early stages and are invested as such. More on this below.
FED EXPECTATIONS: The dot plots suggest the Fed will cut rates three times while the market is pricing in six or seven cuts, a big disparity. There is optimism that the Fed has nailed the peak in inflation but the burden of proof is on them to cut rates before the economy is threatened.
VALUATIONS: At 19x 2024 estimated earnings, the S&P 500 isn’t “cheap.” The largest stocks in the index, however, have really skewed multiples. The “S&P 490” is valued at roughly 17x estimated 2024 earnings. This is a fair multiple if, in fact, we are early cycle. And small caps are very cheap relative to large caps.
YIELD CURVE: The curve remains inverted, and since the curve first inverted, we are within the window of when it would be normal for a recession to start. This recession warning has been dismissed by many investors but we remain concerned.
INFLATION OUTLOOK: Inflation seems to be under control although not yet hitting the Fed’s 2% goal. The inflation of 2021 and 2022 was temporary. Maybe the Fed was right calling it “transitory.”
INVESTOR SENTIMENT: Aggregate indicators show sentiment has reached elevated bullish levels. Remember that bullish sentiment has a contrarian bias.
SECTOR WEIGHTINGS: Technology stocks now account for about 29% of the S&P 500 but below its dot.com peak of 35%. Why is the tech weighting growing? Investors go where the growth is, and tech stocks have been showing impressive growth in earnings.
CREDIT MARKETS: Credit spreads are often an early warning indicator of trouble in the economy (this is the spread between government yields and the yield on low quality corporate bonds). Spreads tend to rise during U.S. equity bear markets. The current situation is the opposite. Credit spreads have collapsed into the end of last year.
GEOPOLITICAL RISKS: If the U.S. gets directly involved in a war with Iran, Russia, or China, equity markets may get hit hard, at least in the short-term. This is one of our dominant themes for 2024 as China and Russia specifically want to change the world order.
CRYPTO: Bitcoin was up about 150% in 2023 (but still down 40% from its all-time high) due to hopes of regulatory approval for Bitcoin ETFs. Backers think Bitcoin ETFs will bring in billions of dollars and expand crypto to far more financial advisors and institutional investors. Our advice on the crypto market remains the same: serious investors should stay away.
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It is interesting to us that some bullish investors believe we are in the early stages of a 1990s flashback. Talk of a soft landing for the U.S. economy has these investors dreaming of a 90s-style boom soon afterward. The Fed funds rate went from 3% in 1994 to 6% by early 1995, and the economy slowed but avoided contraction. The Fed made modest rate cuts in 1995, similar to what economists expect in 2024. The S&P 500 declined 1.5% in 1994 but then had five consecutive years of stellar returns (1995-1999) including 34.1% in 1995.
The “Roaring ‘20s” scenario for this decade assumes real growth of at least 2.5% annually and technological advancement, such as AI, that would boost worker productivity. This would increase the economy’s potential to grow with low inflation, echoing what happened in the 1990s thanks to computer and internet technology.
The key here is worker productivity which is notoriously volatile and hard to forecast. AI’s impact on productivity is hard if not impossible to predict. The range of potential outcomes is huge. But if productivity numbers keep creeping up a 1990s redux is feasible (a lot of things have to go right).
The 1990s flashback scenario assumes we are in the early cycle for both the economy and bull market. As mentioned earlier, we also think we are in the early days of the new bull market but for different reasons. How to invest going forward under this scenario? The best early cycle sectors to invest in are tech, consumer cyclicals, financials, and industrials in our view. We have the great majority of our clients’ portfolios in these four presumed leaders.
We remain bullish on stocks for many reasons. In addition to the positive factors cited in our executive summary, we are excited that there is $6 trillion in money market funds representing tremendous buying power, a resumption of corporate earnings growth, and likely lower interest rates.