January 22, 2024
2024 Outlook: A Look at The Markets
To say that the markets finished 2023 on a strong note would be an understatement. While most of 2023 was characterized by extremely narrow leadership—with only a handful of mega-cap stocks gaining ground and the rest of the market languishing—that all changed around the start of November, when investors began to gain confidence that the Fed really had finished raising rates.
The S&P 500 surged 15.8% (from its October 27 low) into year-end to bring its 2023 gain to 26.3% on a total return basis, but gains were extraordinarily broad based. The Russell 2000 Index (small caps), which had been negative on the year through October, surged 22% to finish up 16.84% on the year, while the Nasdaq Composite led the way having gained 43.4% for 2023. Overseas, the MSCI EAFE Index jumped 16.2% while MSCI Emerging Market Index gained 9.9%. Even cash had its best returns in decades with T-bills returning 5.2%, the highest since 2000. Commodities suffered and were by far the biggest loser as S&P GSCI tumbled 12.2%, weighed down by the drop in crude prices in the 4Q.
While global equity markets posted healthy gains in 2023, it should be noted that most indices were just clawing back the losses sustained in 2022. In fact, even after the headline-grabbing 43.4% return for the Nasdaq in 2023, it still left the index down 3% nominally over the past two years (given the Comp’s 33% decline in 2022). More incredible was the 300+% return on Bitcoin that left the asset basically flat over the 2-year timeline, given its 75% decline in 2022. Other major indices showed losses on their 2-year returns including the Russell 2000, which was down 6.97%. The S&P 500 was up marginally over the past 24 months squeaking out a gain of 3.42%.
Optimism that the Fed may finally be finished raising rates was what fueled the late year run in equities. While the Fed had been saying for months that investors shouldn’t expect rate cuts anytime too soon, it seemed to change its tune after the last Federal Open Market Committee meeting in December. They now suggest that there could be three rate cuts in 2024 (although the market has quickly priced in more than that). This new posture by the Fed seems to make sense as inflation pressures have eased around the world during 2023, removing a burden on global macroeconomic growth. With inflation now steadily improving from its June 2022 peak, it seems the Fed should be able to “give back” some of its rate hikes.
Falling U.S. inflation and possible Fed easing are also increasing talk of a soft landing rather than a recession, hard landing, and bear market. In a soft-landing environment, most analysts predict improved corporate earnings growth and a favorable backdrop for stock prices to extend their gains this year. Leading indicators are still pointing to slowing economic growth, however, and it remains to be seen if a soft landing is achievable.
While odds of a soft landing have increased, markets seem to be already pricing in that scenario, leaving little room for significant further gains. The S&P’s forward P/E ratio (meaning price divided by consensus earnings expectations) is in historically high territory already, having gained 5.5 points since its low of 15.3 in October 2022. It made those gains in anticipation of an earnings recovery, which is now happening. But if earnings do continue to grow from here, the impact on stock prices could be muted by falling P/E ratios.
Another risk is that the Fed could have to walk back on the narrative of rate cuts. Even if the Fed sticks the soft landing, pivoting to rate cuts too soon could threaten its progress on bringing core inflation down further toward its target zone. Lastly, there is a risk that the soft- landing scenario is wrong, and the interest rate shock (over the past 18 months) will negatively impact economic activity as well as the broad equity markets. Geopolitical developments are an additional challenge as they impact commodity prices, inflation, global trade in goods and services, and financial flows. As always, we continue to monitor the progress of the market and make changes accordingly.
All data sourced from Ned Davis Research, Inc. as of 01/4/2024