Weekly Market Analysis - Opportunities Following a Strong Close to 2023

Stocks and Bonds Ended 2023 in the Same Direction

For the last two months of 2023, both the stock and bond markets went in one direction, up. For the fourth quarter of 2023, global equities rose 11.0% and bonds +6.8%. The fact that equities and bonds moved so strongly together is unlikely to continue. The economic outlook is pointing to a gradual slowdown for US labor markets, but healthier, sustainable growth ahead. The Fed is unlikely to provide the immediate “lower rate” satisfaction markets anticipate. We believe a “broadening” of equity market performance is likely to co-exist with last year’s hottest sectors seeing some setbacks or meaningful pauses.

After some strong headlines for December’s job gains, short-term fixed income markets reduced their expectation of Fed easing in March toward 50%. Markets subsequently jumped back to the conclusion that the Fed will soon ease after a weak private sector services survey. All such data is subject to significant noise in the winter months. While the Fed tends to act faster than its own economic forecasts imply, this is an aggressive assumption in our view. Initial action from the Fed in the May-June time window seems more likely.

There is No Bad January Effect

Indices in 2023 were driven higher by large gains for a handful of firms. Yet, the first few days in 2024 indicate that investors doubt that multi-trillion-dollar US tech franchises can continue to beat earnings expectations after a projected 44% EPS gain3 in 2023. Short-term professional traders have vastly different goals and behaviors than committed long-term investors. An ideal trader’s market is one where trading volumes are low, markets are inefficient, and short-term trends can be exaggerated. That’s certainly been the case the first week of 2024.

Following typical patterns, US equity trading volumes briefly doubled in mid-December 2023 and then halved in the period that followed. With this dynamic, low-volume markets become more prone to price swings that are not indicative of underlying trends. Seasoned investors are careful to take market movements during these periods with a grain of salt. Bad “Januarys” do not portend bear markets without the necessary bear market preconditions.

Two recent examples are 2020 and 2021, when bad Januarys meant nothing for strong full year results. 2008 was a different situation. A housing/credit collapse – not a “weak January” – was the fundamental problem. But, if you watch financial news, you will be hearing about the averages without context. In our view, it is not a good idea to extrapolate much from an illiquid holiday market. Such data mining is simply picking information without describing the various circumstances that drove the results.

Don't Doubt the Broadening Out

We can still potentially see a double-digit US equity return for the “average stock in 2024” even if the S&P 500 does not repeat its 26% 2023 return. It does not take an aggressive S&P 500 earnings target to drive double-digit returns for more firms’ share prices in 2024. What it would take is a recovery in a wider swath of industry profits. Last year’s profit decline for the majority of S&P 500 sectors suggest that a broader corporate earnings recovery is more, not less, likely.

 Profitable small and mid-cap growth companies offer an unusually large valuation discount as a starting point. A correction in large cap US tech is likely to be an opportunity. But there are more potential opportunities for growth and diversification than the “Magnificent 7” large tech franchises. With this in mind, investors who dwell on short-term setbacks may miss the opportunity to allocate appropriately for their long-term goals. In our 2024 Wealth Outlook, we noted that there have only been three calendar years of decline in both US equity and bond returns during the past century, with 2022 being one of them. In the two cases where we can observe 24-month returns thereafter, the minimum cumulative gain was 24.2% for a 60/40 mix of the S&P 500 and 10-year US Treasury.