Like most investors, we were pleasantly surprised by the resilience of the economy and performance of the markets in 2023. A year ago, 80% of macroeconomists were predicting a recession for 2023, and investor sentiment was decidedly bearish following the poor performance for stocks in 2022, their worst year since 2008.
As we begin 2024, market returns have boosted confidence, inflation is receding, and a soft landing has become the consensus view for the economy. Even as the outlook has improved, the market will have plenty to digest in 2024, both positive and negative.
The health of the economy, inflation, and the Federal Reserve’s policy actions remain front and center in 2024. In addition, this year is being called the largest global election year in history. According to Bloomberg, 40 countries representing 41% of the world’s population, and nearly 80% of the total global stock market capitalization will have national elections in 2024. We would like to take this opportunity at the beginning of the New Year to share our bullish and bearish thoughts regarding the current economic climate and market environment and to underscore our core investment principles, which are designed to help clients weather a range of market conditions.
The bull case for stocks is predicated on (1) a soft landing for the economy, (2) deft monetary and fiscal stimulus in support of economic growth, (3) continued strength and resilience of consumer and corporate balance sheets, and (4) a repeat of history in a presidential re-election year.
With inflation easing and growth sustaining, the odds of a soft landing have improved, giving additional headroom to the bull case. We believe the bull case is further supported by an accommodative Fed and additional fiscal backing in an election year. At its most recent Federal Open Market Committee (FOMC) meeting in December 2023, Fed Chairman Powell affirmed the end of the hiking cycle, telegraphing three rate cuts in 2024. The timing of future rate cuts is not certain, but the dovish shift in tone is constructive for risk assets. In addition, incumbents are incentivized to avoid a recession in election years, and we expect policymakers to deploy their economic tools to boost the economy this year.
To date, consumers and businesses have adeptly navigated a higher inflation and interest rate environment. Key to the bull case is the continued strength of the current economic environment. Corporations have maintained steady profits and margins while also proactively terming out their debt. Investment-grade credit spreads and default rates are low, reflecting the overall health of corporate balance sheets. Consumers, supported by low unemployment and solid wage growth, have continued to spend on goods and services. Although personal saving rates have fallen and credit card balances have risen, consumers, overall, have been a major source of stability for our consumption-based economy.
Lastly, 2024 marks a presidential re-election year, in which the standing president is seeking re-election. There have been 16 presidential re-election years since 1944, and each time the S&P 500, on a total return basis, has had a positive year.
The bear case rests on (1) the economy faltering due to the lagged effect of higher interest rates, (2) the Fed holding interest rates higher for longer if the economy holds up better than expected, (3) political and geopolitical turmoil taking a toll on the market, and (4) pressure on valuation levels, if earnings growth disappoints.
The market’s rally during the last two months of 2023 provided confirmation to the bulls that a soft landing (declining inflation without a recession) will be achieved. Yet, it may be premature to declare victory, due to the delayed effect of the higher interest rate environment that we’ve been in since the second half of 2022. The Fed still faces a delicate balance regarding the amount and timing of future policy decisions. If the Fed cuts too soon, it could reignite inflation, and if it waits too long to cut rates, it may induce a recession. Time will tell, but a miscalculation by the Fed would accrue to the bear case.
While markets often perform best when they climb the proverbial wall of worry, geopolitical tension and polarized domestic elections add a complex layer of uncertainty that could derail positive sentiment.
With the year-end rally, recent investor sentiment readings have become more bullish, and market valuation levels are trading above their long-term historical average. Mega-cap companies have led the way, with the top 10 largest stocks in the S&P 500 trading at 27 times forward earnings while the remaining 490 stocks trade at a more reasonable 17 times forward earnings. Earnings revisions have begun to turn higher in support of current valuation levels, but any deterioration would be a concern for the market in 2024. On balance, the market appears to be pricing in an optimistic outcome, which tempers enthusiasm for excess returns this year.
At The Fiduciary Group, we focus on constructing portfolios that enable our clients to maintain their asset allocations throughout the market cycle, especially during the stressful periods when it matters most. In other words, we accept the fact that we cannot predict bouts of volatility or periodic downturns in the market. Instead, we devote our time and attention to preparing clients to weather changing market conditions, including bull as well as bear periods.
We believe in the importance of strategic asset allocation and diversification, so that clients’ investment strategies are aligned with their risk tolerance as well as their future cash needs. We focus on each client’s ability to bear risk and their capacity to withstand the swings that accompany changes in market values. Individual client circumstances always inform our investment decisions, and we understand that every client situation is unique.
Ultimately, our goal is to intelligently balance the mix of stocks and bonds to adequately capture the benefits they provide for investors while also remaining cognizant of their shortcomings. Our objective is to set asset allocations so clients will have the conviction to stay invested throughout the market cycle and reap the benefits of long-term compounding over time.
As investors, our greatest strength lies in how we choose to react to market volatility. We affirm our longstanding belief that a balanced, diversified, strategic approach helps clients stay invested throughout a range of market and macroeconomic cycles and puts them in the best position to achieve returns and to accomplish their goals over the long run.
Please feel free to reach out to us with any questions. As always, we greatly appreciate the trust our clients place in us.