2024 Outlook: Continuing the Climb
Summary
- Stocks climbed a “wall of worry” in 2023, shaking off bad news and negative forecasts to post strong returns. The S&P 500 gained 26% while the NASDAQ Composite soared 45%, although leadership was narrowly concentrated in Large Cap Growth stocks.
- The Fed raised interest rates four times to the highest levels since before the 2008 financial crisis before pausing in July – widely believed to be the last interest rate hike in this cycle.
- Inflation surprised to the downside in 2023, with CPI falling from 6.5% to 3.4%, supporting expectations for rate cuts in 2024.
- We view a recession in 2024 as unlikely and believe that economic growth and stock market strength can continue into 2025.
- Fixed income yields remain attractive relative to historical averages, and expected rate cuts should act as a tailwind for bond prices.
- While our outlook for markets is positive, diversification is key. We are expecting to see market leadership broaden to include more than just the largest US growth companies.
Market Recap
It is often said that stocks climb a wall of worry during bull markets, shaking off “bricks” of bad news and negative forecasts as they advance. The US stock market did just that in 2023, overcoming a challenging backdrop to post exceptional gains. Early last year we saw three of the four largest bank collapses in US history. The Fed raised interest rates four times to levels last seen before the 2008 Financial Crisis. Doom and gloom forecasts were frequent, with many calling for recession.
Despite those challenges, the S&P 500 index gained 26%, while the technology-heavy NASDAQ Composite index soared by almost 45%. Bond yields were volatile, but the 10-Year Treasury yield ended the year right where it started. Amidst all the negativity, the economy continued to prove its resilience. Labor markets moderated but companies continued hiring, the consumer bent but didn’t break, inflation cooled faster than predicted pulling forward expectations of Fed rate cuts. Add it all up and the economy grew by 3.1% last year, as measured by GDP.
Concerns were plentiful entering 2023, chiefly among them being inflation. The Consumer Price Index ended the year at 3.4% after entering at 6.5%. The Fed’s preferred measure of inflation, the Core Personal Consumption and Expenditures index (Core PCE), fell to 2.9%. While both measures of inflation remain above the Fed’s target of 2%, markets found the trajectory promising, increasing expectations that the Fed would soon be able to cut interest rates. At one point, the market predicted five to six rate cuts in 2024 beginning as early as March.
Labor markets also proved their resilience in 2023. Hiring cooled during the year but companies did not stop hiring. The economy added an average of 255,000 jobs per month last year, while the unemployment rate ticked up slightly to 3.7%. Job openings and quits fell below 10 million and 3.5 million respectively, as demand for labor slowed and employees were less likely to look for new jobs. Initial claims for unemployment insurance gradually increased into the summer before falling back to cycle lows by the end of the year.
Consumer spending also remained resilient. Despite slowing slightly at the start of the year, US Retail Sales grew by 4.8% in 2023 as Americans continued to spend on goods and services.
With economic growth and inflation data coming in better than predicted, you might expect that strength in the stock market was broad based. However, stock gains were largely concentrated in a handful of large- and mega-cap growth companies. Growth outpaced value by over 30%[i], while the so-called “Magnificent Seven” group of stocks including Nvidia, Microsoft, Apple, Amazon, Tesla, Meta, and Alphabet returned an average of 111%. The Magnificent Seven accounted for almost half of the market-capitalization weighted S&P 500 Index’s return. The equal-weight S&P 500 Index returned 14%.
For much of 2023 investors were concerned about rising interest rates and a looming recession, which acted as a headwind for more economically sensitive sectors and smaller capitalization companies. Early in the fourth quarter the equally weighted S&P 500 index was negative for the year before lower-than-expected inflation, falling bond yields, and hopes for Fed rate cuts in 2024 drove a sharp rally to end the year.
The question for investors now is can the stock market continue to climb the wall of worry, and if so, can performance continue to broaden out to the rest of the market and not just a handful of “Magnificent” stocks?
Outlook
Entering this year our expectations for an economic recession are relatively low, giving it a 25% chance. The economy had proved to be quite resilient all throughout last year, and we believe that resilience can continue in 2024 if the US consumer holds, and the Fed doesn’t make a policy mistake. The fall in inflation over the past year while growth continued allows the Fed the opportunity to guide rates lower while growth slows back to trend levels without the need for an economic recession.
In fact, we believe that markets may have already experienced an “asynchronous recession” in 2022-2023, where parts of the economy contract independently but not simultaneously. At the onset of the Fed’s rate hikes we saw the housing market hit first, followed by manufacturing and technology. In early 2023 we saw the unintended consequences of higher interest rates when Silicon Valley Bank, Signature Bank, and First Republic Bank collapsed sparking a regional banking crisis. That crisis could have sent the economy into a traditional recession, however quick action by the Federal Reserve prevented the crisis from spreading.
In asynchronous recessions parts of the economy may experience recovery while others are in contraction. While the banking crisis was ongoing, technology stocks were recovering from a brutal 2022, and eventually led the broader market to new highs by the end of the year. Other sectors like travel, leisure, and homebuilders also soared.
We’ve stated in the past that history suggests Fed rate hiking cycles precede recessions, but they don’t always have to. We look to the tightening cycle of 1994-1995 as an example, where the Fed successfully engineered a soft landing, cutting rates gradually from 1995 to 1999 during a period of strong stock market and economic growth. Later in 1999 the Fed began a new tightening cycle which eventually led to the bursting of the Tech Bubble.
We’re cautiously optimistic that the Fed will be able to pull off another soft landing, but recognize that they don’t have much room for error and must balance adjusting rates to a level appropriate for the inflationary environment without either being too restrictive or too stimulative, which could reignite inflationary pressure. Either of those scenarios would be negative for markets. Our base case assessment calls for three to four rate cuts in 2024, beginning in May or June.
High frequency data on labor markets, consumer spending, and inflation will be very important to watch this year as all will heavily influence the Fed’s decision-making process and can give us insight into an economy that is slowing down, but still growing, versus an economy that might experience a contraction.
Our outlook for stocks in 2024 is positive, but we expect more muted returns relative to what we saw in 2023 – partly because we believe the stock market has already “priced in” Fed rate cuts, and we expect that volatility will be elevated as investors digest high frequency economic data. Stocks are moderately expensive, with the forward price-to-earnings (P/E) ratio on the S&P 500 at 19.8 times earnings, compared with the 30-year average of 16.6 times[ii].
If economic growth slows, but doesn’t stop, and the Fed cuts interest rates to match moderating inflation, we think the narrow equity markets of last year should broaden to include large cap value and small and mid-cap stocks. We saw early signs of this in the fourth quarter, but large cap growth companies have been far and away the best performers over the past year.
While we favor US companies, we do see opportunities for international stocks, both in developed countries and emerging markets. On a valuation basis international stocks look more attractive than the US[iii], and expected Fed rate cuts could provide a currency tailwind for investors in foreign companies. However, we remain skeptical of China, which has struggled to stimulate its economy post-pandemic and is enduring a real estate crisis. We are also acutely aware of the geopolitical risks in Eastern Europe and the Middle East.
We are very constructive on fixed income markets in 2024 and beyond. Not only are yields attractive across most sectors, trading above their 10-year averages[iv], but falling interest rates should act as a tailwind for bond prices. As interest rates fall, the value of a fixed-rate bond increases because of its higher coupon. The opposite is true when interest rates rise, as we experienced in 2022.
Bonds have typically performed well in the period after a rate hike pause. According to research by Capital Group, in the previous four Fed tightening cycles core bonds have returned 10.1% one year and 7.1% (annually) five years after the last rate hike, handily outperforming cash which returned 4.7% and 3.2% in the respective periods[v].
As much as the benefit of hindsight might make investors wish they concentrated more of their portfolios in the hot stock or asset class of the moment, we know from experience that there’s no foolproof method for predicting future returns. Investors can express their views by modestly leaning into or away from individual asset classes, but we believe it’s important for successful long-term investing to stay diversified. The quarter-by-quarter asset class performance quilt chart above[vi] shows just how much asset class performance has varied from one quarter to another since 2020.
You may have noticed that we haven’t mentioned the upcoming Presidential election, and that’s for good reason. Monetary policy and economic fundamentals will be the primary driver of market returns this year, not the outcome of the election. Election season might lead to some volatility, but there is little historical evidence suggesting a correlation between Presidential elections and stock market performance[vii].
We pride ourselves in collaborating with our clients to develop thoughtful investment plans to help achieve their goals. As we continue through 2024, we believe investors are best served by maintaining discipline and focusing on the long-term view. We will continue to evaluate opportunities to reallocate portfolios as the investment environment evolves, and in taxable accounts we actively look to take advantage of volatility and add value by tax-loss harvesting.
In company news, Advisors Financial is proud to welcome our newest team member, Gordon Daisley. Gordon joins us as a Paraplanner primarily supporting Joe and David’s relationships. Gordon worked as a civil engineer for over 17 years but was always drawn to financial planning (it’s in the family—his father was a financial planner). He finally saw the light and changed careers! Gordon completed his CFP® coursework last year, and he passed the CFP® exam in July. He is exited to take on this role and expand as it grows with Advisors Financial.
[i] Ycharts.com Data. As measured by the Russell 1000 Growth Total Return Index and Russell 1000 Value Total Return Index.
[ii] JPMorgan 1Q 2024 Guide to the Markets, Slide 5: S&P 500 Valuation Measures. https://am.jpmorgan.com/us/en/asset-management/protected/adv/insights/market-insights/guide-to-the-markets/
[iii] JPMorgan 1Q 2024 Guide to the Markets, Slide 46: International Equity Earnings and Valuations. https://am.jpmorgan.com/us/en/asset-management/protected/adv/insights/market-insights/guide-to-the-markets/
[iv] JPMorgan 1Q 2024 Guide to the Markets, Slide 37: Fixed Income Valuations. https://am.jpmorgan.com/us/en/asset-management/protected/adv/insights/market-insights/guide-to-the-markets/
[v] Capital Group. “Now may be the time for core bonds: Five themes for 2024.” https://www.capitalgroup.com/institutional/insights/articles/core-bond-themes-2024.html
[vi] Ycharts.com. Asset Class Performance – Quarter by Quarter
[vii] US Bank. “How presidential elections affect the stock market.” https://www.usbank.com/investing/financial-perspectives/market-news/how-presidential-elections-affect-the-stock-market.html
Important Information
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The information provided is for educational and informational purposes only and does not constitute investment advise and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor.
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