“Of course, the immediate future is unknown; America has faced the unknown since 1776….Periodic setbacks will occur, yes, but investors and managers are in a game that is heavily stacked in their favor.” – Warren Buffett, 2012 Berkshire Hathaway shareholder letter
Review
The stock market exceeded consensus expectations in 2023 despite dire predictions of a pending recession at the start of the year and the Federal Reserve continuing to raise interest rates early in the year. The economy was stronger than expected and was propelled by consumer spending on experiences and services rather than goods. Spending on travel, concerts, movies, and other experiences was supported by a strong labor market and remaining savings accumulated during the pandemic. Easing inflation, future prospects for productivity gains from artificial intelligence, and lower interest rates led to strong gains in the stock market as the year progressed.
The Federal Reserve increased interest rates in 2023 to their highest level in twenty-two years in order to fight inflation. With inflation continuing to subside throughout the year, the Fed stopped its interest rates hikes after the July 2023 meeting. However, interest rates, most notably the 10-year treasury yield, continued to increase through mid-October to just over 5%. But by December, the 10-year treasury yield had dropped to below 4%, providing a market environment conducive to equity gains as the year closed out. The stock market also benefitted during the last few months of the year from the expectation of potential Fed interest rate cuts beginning as early as March 2024.
The broad stock market indexes posted very strong returns for 2023. The S&P 500 Index finished up 26.3%, the NASDAQ Composite completed the year up 44.6%, and the Dow Jones Industrial Average, while lagging the other two, still posted a 16.2% return. A large part of the gains for the S&P 500 were the outstanding results of the so called “Magnificent Seven” stocks – Apple, Alphabet, Amazon, Meta Platforms, Microsoft, NVIDIA, and Tesla. Even with their strong performance in 2023, many analysts are projecting good things to come for these seven stocks based on valuations that are not extreme and financial growth prospects that exceed those of the overall market. David Kostin, head of U.S. equity strategy at Goldman Sachs, noted the following regarding the Magnificent Seven, “They are expected to grow revenues more quickly at better profit margins, and they’re plowing a lot more of their cash back into the businesses as compared with the typical company.”
The strongest sectors during 2023 were Technology, Communication Services and Consumer Discretionary, which are the three sectors where the Magnificent Seven reside. The technology sector, notably Apple, Microsoft, and NVIDIA, had its best performance since 2009. The communications services sector enjoyed its best annual performance with the likes of Alphabet and Meta Platforms surging. Finally, the consumer discretionary sector also enjoyed its best performance, aided by strong consumer spending that propelled stocks such as Amazon and Tesla higher. The weakest sectors during the year were Utilities, Consumer Staples, and Energy, which all tend to be higher dividend stock sectors. Although, many stocks in these sectors have performed better recently as interest rates have decreased and investors have gravitated a little more towards dividend paying stocks.
Outlook
Now that we are seeing a decrease in the growth rate of inflation some market participants are forecasting anywhere from 0.75% to 1.50% in interest rate cuts by the Federal Reserve in 2024. Goldman Sachs expects three consecutive 0.25% cuts in March, May, and June, followed by one cut per quarter until the federal funds rate reaches 3.25-3.50% by the third quarter of 2025. The Fed would likely embark on a rate cutting cycle because either its target inflation rate of 2% is achieved, or to bolster the economy from worsening economic conditions.
Some of the challenges the market will encounter in 2024 include a prolonged inverted yield curve, an ongoing possibility of a recession, and a continued weakening in leading economic indicators as measured by the Conference Board. Broad economic growth is generally not projected to be very strong in 2024. Goldman Sachs is one of the most optimistic firms in forecasting a 2% Gross Domestic Product (GDP) growth rate for 2024, while the consensus from many firms is for only a 0.9% growth rate. The Federal Reserve projects GDP to grow by 1.4%.
One significant positive factor that can be viewed as bullish for the stock market in 2024 is the ample liquidity not currently invested in the stock market. Crane Data, a money market and mutual fund information company, estimates there are $6 trillion held in money market funds. As short-term interest rates have increased, investors have flocked towards the attractive rates offered by money market funds. Additionally, American household wealth achieved an all-time high of $151 trillion as of September 30, 2023.
David Kostin from Goldman Sachs projects the S&P 500 will increase to 5,100 by the end of 2024 for a total return of approximately 8% including dividends. Kostin believes decelerating inflation and future interest rates cuts will propel the market higher. Kostin also noted potential cash inflows into stocks as a positive influence for the market in 2024 – “In addition, falling yields might represent one catalyst for a reversal of recent fund flow dynamics that have challenged equities. Investors have poured $1.4 trillion into money market funds as interest rates have climbed, while US equity funds have received just $95 billion of inflows. As rates begin to fall investors may rotate some of their cash holdings towards stocks.”
Ed Yardeni, president of Yardeni Research, has a slightly more bullish forecast of 5,400 for the S&P 500 for 2024, or an approximate gain of 13%. But Yardeni doesn’t believe the market needs the Fed to cut rates for stocks to move higher. He recently stated, “If the economy is doing reasonably well and inflation is coming down, the Fed isn’t going to rush to lower interest rates – there isn’t going to be any need for it. These are the kinds of rates that we had before the financial crisis, and the stock market did well, the economy did well. We’re basically back to the old normal.”
In CFRA’s 2024 annual forecast report, they note a number of interesting potential positive factors for 2024:
- Election years of first-term presidencies have exhibited surprising resiliency, recording an average total return gain of 15.5% and a 100% frequency of advance since WWII, regardless of whether the current president was reelected or replaced.
- The current bull market started on October 12, 2022. Second-year bull markets since WWII gained an average of 12.6%.
- Since the Fed began communicating hikes and cuts in the Fed Funds rate in the late 1980’s, the S&P 500 gained an average of 14.1% in price in the typical 11-month period between the last rate hike and first rate cut, rising in five of six occasions. The last rate hike in this cycle was July 26, 2023.
- “Let Your Winners Ride.” While embracing the “First to Worst” sector rotation strategy has been rewarding following down years, the reverse has been true after up years. The S&P 500 has gained an average of 9.8% in price during all years since 1995, rising in 73% of those years. Owning the top three performing sectors following up years and the bottom three following down years delivered an above average price gain of 11.9%, while rising 82% of the time and beating the S&P 500 in 70% of the years.
As we stated in our opening quote by Warren Buffett, the immediate future is unknown. Investors should anticipate that 2024 will be a volatile year as the market will be impacted by shifting expectations for the economy and the markets, while various geopolitical surprises may occur, along with heightened volatility associated with a presidential election year.
Bespoke Investment Group has an interesting comparison between a casino and the stock market. “Casinos make money by making sure bettors eventually lose more often than they win. The stock market is the opposite. The longer you play, the better your odds. Historically, the odds of the S&P 500 being up over any one-month time frame have been 63%. Over a year, the odds of a gain jump to 75%, and over eight years, they surge to 97%. Since 1928, all 16+ year time frames have seen positive returns.”
Barron’s summed it up as follows in a recent publication – “Perhaps the main message for 2024: Don’t try to time the market. Although many investment strategists see a back-end-loaded year, better returns could come even sooner, depending on the pace of rate cuts, the evolving economic outlook, and turns in investment sentiment.”
Sincerely,
Marietta Wealth Management, LLC
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