2024 Outlook – January 8, 2024

Following the September/October market downturn, 2023 ended with very strong November/December returns for both stocks and bonds, capping off an unusual year for the capital markets. From their October lows, the S&P 500 rose over 15% and US Aggregate Bond Index over 9%, while the 10-year US Treasury yield fell sharply from 5.0% to 3.9%. While the ups and downs we experienced are a normal part of the investing journey, the wide disparity in performance between different types of companies was not. First discussed in our 6/12/23 blog post, the extraordinary 2023 relative performance spreads persisted through year end with high volatility over low volatility (+32.9%), growth over value (+31.2%), and market cap-weighted over equal-weighted (+12.4%).¹ As we showed in June, historically there have been rebounds in these indices following periods of large relative underperformance. The disparities were also evident in S&P 500 sector performance, with 8 out of the 11 sectors underperforming the S&P 500 by an unhealthy -20.1% average.² Importantly, the biggest driver of these sector performance gaps was not relative earnings growth but relative valuation changes, which we believe sets these underperforming sectors up for better relative performance in the future.³

In our 2023 Outlook from 1/9/23, we said, “We believe 2023 will be characterized as the Battle between Inflation and Growth.” Fast forward one year, and this is still definitely a key issue for the market coupled with when the Federal Reserve will begin to cut interest rates. While the year-over-year core CPI inflation rate has dropped from 6.0% in November 2022 to 3.9% in November 2023, this is still well above the Federal Reserve’s 2.0% target.⁴ Near term, this means that the Federal Reserve will likely keep interest rates higher than normal to make sure inflation keeps coming down, thus offering the market less support than usual in the event of a downturn. There are many reasons to believe inflation will continue to come down, most notably supply chain improvements, wage growth normalization, and the moderation in housing and rental prices.⁵ However, the Federal Reserve may wait to see this show up in their preferred inflation metrics before acting to cut rates significantly.⁶ Increasing government bond supply due to high budget deficits could also act to keep interest rates higher in 2024.⁷

On the growth side, the US so far has avoided the feared economic recession that many predicted (and still predict) due to higher interest rates. As discussed in our 8/10/23 blog post, the low fixed interest rates that homeowners and large companies locked in during 2020-2021 have mitigated the economic impact from high interest rates, but they do dampen demand for new purchase/capex decisions. The labor market has softened over the course of the year, but remains strong with a sub-4% unemployment rate and still more job openings than there are unemployed persons.⁸ The ISM Purchasing Managers Index has been in contractionary territory for Manufacturing for all of 2023, but is balanced by continued expansion in Services.⁹ International economic growth is expected to remain slow in 2024, with Europe continuing to struggle with weak manufacturing and high inflation, and China dealing with high debt levels, a property bust, and a declining population. Japan may continue to be a bright spot with its GDP growth expected to be above trend in 2024 and several ongoing corporate governance reform initiatives.¹⁰

Globally, 2024 will be the year of elections. There will be over 70 major elections this year covering over half the world’s population, the largest percentage in history.¹¹ The first of these to watch is in Taiwan on January 13. Currently, the incumbent pro-independence party is expected to win resulting in a status quo outcome, but this could potentially increase tensions with China. The US presidential cycle will kick off in earnest on January 15 with the Iowa Caucuses. As the election noise grows to deafening levels this year, know that the US stock market and US GDP have historically risen at similarly strong average rates during both Democratic and Republican administrations.¹² We will also be watching for new developments in the Russia/Ukraine War, the Israel/Hamas War, and heightened risks of broader conflicts in the Middle East.

The other near-term catalyst to watch will be the upcoming Q4 corporate earnings season, which kicks off on January 12. Some key corporate questions to watch this year:

1. Will declining inflation lower corporate revenue growth more than it helps decrease their costs?
2. What is the status of the American consumer now that excess savings from the pandemic have been mostly exhausted?
3. The benefits of artificial intelligence advances so far have only accrued to a handful of companies, when will this technology start to impact the broader economy?
4. Will any of the US government’s major antitrust cases against big-Tech companies prevail and force major changes?

When looking ahead to all that could transpire this year, there are numerous potential outcomes from many geopolitical and corporate crosscurrents. Dealing with major global events have been a feature of capital markets since their inception, and this year will be no different. Historically, thanks to the resilience and ingenuity of the people, fueled by the engine of capitalism, over time the economy and stock market have endured and thrived. For our part, we plan to remain disciplined with our process of focusing on the long term and owning a diversified portfolio of high-quality companies. For our clients, we recommend staying the course at their chosen target risk level and avoid trying to time the market. Together, we believe this to be the best strategy to achieving clients’ long-term investing goals.

We wish you all a happy, healthy, and prosperous 2024!