Last year, we titled our outlook piece “Prospects Brighten as Fed Slows” with the focus on the Federal Reserve because we believed it held the majority of control over the path of the economy and financial markets. That was the correct narrative as we waited with bated breath for every monthly economic report on prices, jobs, wages, and interest rates, which all went the direction we wanted. The year finished with strong positive returns across many asset classes, thanks to a year-end rally prompted by the Fed’s important pivot on the direction of interest rates in December. We provide a more in-depth review of the 2023 market in our corresponding piece “The Great Investment Year No One Saw Coming.” HYPERLINK THIS
A new year is upon us and that means creating some new year’s resolutions. The title of our 2024 outlook resembles a resolution many of us make each year: all things in moderation. We thought it was a fitting phrase given our view of what this year holds in store for us. Our crystal ball is still broken, but we do spend a fair amount of time assessing market and economic conditions and expectations to provide our clients and readers with our assumptions for the coming year. To expand upon the bullet point summary above, let’s dive in a bit deeper to each topic as we frame our moderate, but positive expectations for 2024.
A positive, albeit slowing, economic backdrop coupled with interest rates declines are two main reasons we are still positive on U.S. equities. As a reminder, over the last 40 years, U.S. equities have been positive for 32 out of those 40 years or 76% of the time. We think 2024 is another one of those years.
However, as we mentioned in our title, we are not envisioning double-digit returns like we have seen in eight of the last 10 years (one of those years being a negative double-digit return). Rather, we see a more normalized market with equity returns to end the year up 5-8% for the major U.S. index, S&P 500.
We expect market breadth to improve as well, which it usually does when the Fed stops cutting rates. As the chart below illustrates, rate hike halts have been historically good for high quality stocks. We expect a broader range of stocks and industries to return positive returns in 2024.
We don’t anticipate a market where just seven stocks (the magnificent seven we discussed in our 2023 review) drive most of the index return, especially given the valuation gap we currently have. The market-cap weighted price to earnings valuation on current 2024 S&P 500 earnings is about 19.4x compared to the equal-weighted index at about 15.7x. This is the widest valuation gap between those two index weights since 2010. Put another way, if we exclude the top seven returning stocks from the S&P 500 and look at the valuation of the remaining 493 of the index, the valuations of this much broader groups of stocks is much lower and in line with 20-year average valuation for the S&P 500. 1
Additionally, as investors begin to feel more confident about growth and risk assets, we see an opportunity for them to deploy the hefty amount of cash held in money market accounts. The graph below show how much cash has been stockpiled since the global pandemic. Even if a part of that cash gets redeployed, it would benefit stocks and bonds.
While we see modest returns, we do note that as of January, market expectations for Fed rate cuts are faster and deeper than the Fed is indicating. We believe there will be fewer than the 5-6 cuts the market is expecting. If we’re right, then markets need to adjust their thinking on monetary easing and that is usually negative for market pricing. Thus, we could see pockets of price pullbacks during the year with a reset of rate cut expectations. Additionally, the year-end rally may have borrowed a bit from 2024. From the end of October through December 2023 the S&P posted a 16.5% gain, the Nasdaq a 19.7% gain, and Europe’s Stoxx 600 index a 16.8% gain! We basically got two full years’ worth of returns in a matter of days. That type of rally is likely to cool down and consolidate a bit in the near-term, in our opinion.
We expect global central banks to follow the lead of the Fed and signal a pause and then eventual easing of monetary policy. Inflation around the world has pretty much run lockstep with our inflation rates in the U.S.
Easing monetary policies will be a strong fundamental backdrop in 2024 for risk assets, like equities, to do well. We believe this will be true in both the U.S. and Europe, where most of our international exposure exists for our clients and expect positive returns outside the U.S. as well.
International stocks are still and have continued to be much cheaper than U.S. equities. According to J.P. Morgan’s research, international stocks (MSCI All Country World Index ex. U.S.) have a current price/earnings (P/E) valuation of 12.9x 2024 estimated earnings. That compares to the S&P 500’s P/E ratio of 19.5x. This 34% discount of non-U.S. equities is the largest it’s been in 20 years. We know, however, that cheap stocks alone don’t lead to higher returns as this valuation discount has been in place for the last 10 years, and yet the U.S. still handily outperformed its international equity counterparts.
We expect another year when we will get some real income from our fixed income investments. Higher yields than in years past, combined with high-quality fundamentals in the corporate and municipal credit spaces will likely make 2024 another good year. We expect the yield curve to steepen during the year with the most movement occurring with shorter-dated maturities moving down as the Fed signals and begins to cut short-term rates. Fixed income assets have historically performed well after the Fed pauses and then eases and we see this occurring in 2024.
We note, however, that we are starting the year off after an amazing 4Q23 rally in the bond market that pushed yields almost a full 1.0% lower and raised prices in a matter of weeks. November fixed income returns were one of the best months in decades. Yields on the 10-year treasury peaked at 5.0% in late October before the market’s massive rally which led to yields closing the year out at 3.8%. Today we are still slightly sub-4.00% on the 10-year treasury. Below is a short list of a few fixed income benchmarks showing how much they rallied in 42 trading days:
Massive sprint into year end from near-term low back on 10/27/23 to the peak on 12/28/23
Municipal Bond Market
Municipals bonds are still attractive versus corporate bonds or treasuries for those in tax brackets of 32% and higher because the after-tax yield advantage for municipals (fed and state tax free income). Current tax equivalent yields have come down from the 8.5% range we witnessed in 2023 for MA residents in the highest federal tax bracket. Today they sit closer to a 6.8% tax equivalent yield, better than the U.S. 10-year treasury at 3.99%. Attractive yields along with good fundamentals still make the municipal bond asset class one of our favorites for stable returns and income.
We note that overall fixed income markets today look expensive and could be due for a pause. At the moment in the municipal space, we are waiting for slightly better valuation entry points and for supply to come back into the market. Hopefully we will see these dynamics shift in the next month or so.
We ended the year with an overweight position to short duration versus the benchmark. As you may recall, we moved clients out of all intermediate bonds in early 2022 and into ultra and short-term bonds and cash as we saw a pattern of multiple Fed hikes. In 2023, we made one move to add some intermediate bond duration back to our clients’ portfolios, but we are still positioned shorter than the benchmark. In 2024, we expect to add back to duration and move closer to a neutral stance relative to bond benchmarks. While cash yields stand attractively around 5.0% in early January, that is not likely to last given the Fed’s dovish pivot.
We have always viewed fixed income as the ballast in a portfolio. It provides diversification from equities and protection from equity market shocks and economic slumps.
The economic data in 2023 provided a great backdrop for the Fed to signal a pause and then reduction in rates. By year end we saw continued consumer growth, new jobs being created, wage growth continuing and inflation slowing - data the Fed needed to see. For 2024, we expect the Fed to hold current rates steady at the next three meetings (January, March April). Assuming inflation continues to slowly decline towards the Fed’s target, we see a rate cut at the June and/or July meeting. If the economy can withstand rates at those levels, we expect the Fed to be reluctant to manipulate further as we approach prime election season (August-November). The Fed is not a political body and does not want to look like one. We believe the only reason the Fed would cut rates close to the elections is because the economy would be heading for a hard economic landing and the Fed needs to run to its aide. That is not our base view, however, so we expect a few cuts mid-year and then a continuation of cuts post-elections. The market reacts quickly to economic data, and we believe investors will be rewarded by paying attention to the markets versus waiting for the “all clear” sign from the Fed.
Our outlook expects a slow, but resilient economy for 2024.
Last year, 100% of all strategists and economists were forecasting a GDP recession in 2023, meaning there would be at least two consecutive quarters of negative GDP growth. That forecast went horribly wrong, in a good way, as the U.S. recorded three positive GDP quarters thus far (4Q will come out in 2024). Real GDP grew 2.2%, 2.1%, and a surprisingly strong 4.9%, in the first three quarters of the year.
We expect growth will slow from a near 5.0% pace in the last reported quarter to a more modest 2.1%-2.5% rate for all of 2024 with no consecutive GPD declines expected.
Sandy Cove views Goldman Sachs Investment Strategy Group’s global GDP outlook to be in line with our thinking, knowing that we are all taking educated guesses. Their views are seen in the table below and point to growth in all regions of the world.
A more conservative view on worldwide output comes from the World Bank, which semi-annually prognosticates on their global growth views. They see a modest slowdown from 2.6% world GDP in 2023 to 2.4% in 2024. However, they expect the U.S. to slow materially to GDP growth of only 1.6% and rest of world growth at 3.9%, with East Asia (China, Indonesia, Thailand) coming in with a strong 4.5% GPD growth expectation for 2024. Time will tell who’s right.
Job growth continued to surprise to the upside in 2023 and we had a few months where economists’ expectations were off by 100,000 jobs! There are still 8.79 million job openings in the U.S. today and the unemployment rate remains low at 3.7% providing us with strong labor dynamics for 2024, which should benefit financial markets.
A historically low unemployment rate, a strong job market, millions of job openings, strong household balance sheet, and wage growth have made consumers feel confident in spending. We see no change to spending in 2024, though the components may be different. After a few consecutive years of high spending on services (concerts, vacations, etc.) we see this area slowing a bit after much of the pent-up demand has been satisfied.
The chart below shows just how important the U.S. consumer is to the health of our economy. It drives over two-thirds of GDP.
Strong asset returns in bonds, equities, and property values have also made the consumer feel good about their balance sheets and net worth, usually called the wealth affect. After a contraction of wealth in 2022, households balance sheets recovered nicely, bringing the ratio of net worth to disposable income to its 2nd highest level in history!2 The chart below from Goldman Sachs illustrates this point.
We expect GDP growth to slow in 2024 and corporate earnings to do the same. We see no indication of a recession and are not calling for one. Corporate earnings and Fed rate cut expectations likely need to adjust downward a bit, which would put temporary pressure on asset prices. Therefore, we see an overall modest growth year for the economy and markets when we close out 2024. Below we note a few positives and negatives that could occur but are not in our current thinking.
In conclusion, we were pleasantly surprised to see such a large rebound in equities and fixed income in 2023.
Still, we expect the entire year to have positive returns, albeit more moderate ones.
There are plenty of unknown risks in the world, and the best protection is to diversify and plan ahead. We continue to pay attention to our clients’ diversification through asset allocation and investment strategy selection. Any asset allocation changes we make to our client portfolios will be communicated through our quarterly market summaries or flash reports.
We can’t end a discussion on this year without recognizing the national election and how that might impact client sentiment and their thinking on markets. Short-term fluctuations can occur as the public coalesces around certain candidates and digests the most recent polls (usually wrong in years past). However, longer-term, markets are agnostic as to which party sits in the White House. We leave you with a few historical datapoints that will hopefully eliminate some investor worries in an election year.
As always, your Sandy Cove team is available to answer any questions about the markets or your portfolio. We wish you all a happy and healthy new year and best of luck with your resolutions!
1Taking stock: Market views from BlackRock Fundamental Equities, Q1 2024
2 Goldman Sachs: “US Daily: Wealth Effects Will Support Consumer Spending Growth in 2024” Jan 8, 2024, (Peng)