Financial Forum - January 2024
Market Commentary – The Secretariat Market
Famed Triple Crown winner Secretariat was a thoroughbred racehorse known for his closing speed. Big Red, as he was also known as, still holds the fastest time record in all three Triple Crown races, including a record-breaking, 31-length victory in the 1973 Belmont Stakes. 2023’s stock market performance reminded me of Secretariat, as the S&P 500 ended the year with nine consecutive up weeks, its longest weekly winning streak since 2004. The reason for this hot streak was simple – The Fed. In its final meeting of the year, the Federal Reserve surprised investors with a “dovish shift,” as it abandoned its “higher for longer” stance of the past several months. Barring any surprise surge in inflation, the Fed signaled three rate cuts in 2024. As expected, investors started their New Year celebrations early, sending the S&P 500 to new highs for the year and just a smidge below its January 2022 all-time high. However, if one looks at the S&P 500 over the past two years, they will see that it basically went nowhere, closing this year at 4769.83 versus 4766.18 on December 31, 2021; an advance of only 3.65 points (0.077%).
Of course, no discussion of the 2023 stock market would be complete without discussing the “Magnificent Seven” – Apple, Microsoft, Amazon, Alphabet, Meta, Nvidia, and Tesla. These technology mega cap stocks were up an average of 111% and fueled about 60% of the entire stock market’s gain, per Forbes. Investors piled into these stocks, like they did in the 1970s with the “Nifty-Fifty” and in the late 1990s with “Dot-Com” stocks. However, most of these gains defied company fundamentals. Apple, for example, had a bad year by their standards, yet sells at a P/E ratio of 31.4 and has a market capitalization over $3 trillion. In 2023, Apple had four consecutive quarters of shrinking revenues, its longest such streak in 22 years. And Tesla, due to increasing competition and lower EV demand, resorted to heavy discounting, causing its gross margins to shrink by seven percentage points versus a year earlier. Their net income fell 44%, yet the stock price doubled in 2023 and sells for 80 times earnings. I guess when it came to the Magnificent Seven, FOMO (fear of missing out) ruled the day. Something doesn’t seem quite right…
INFLATION AND THE FED…
Anyone who has ever played golf on a regular basis knows that taking three or four strokes off your handicap is a lot easier for a 20 handicapper than it is for a five handicapper. The reason is obvious – a 20 handicapper has a lot more areas for improvement, making it easier to shave off a stroke here and there. In other words, they have a lot of low hanging fruit left on their tree. A five handicapper, however, already has a fairly proficient game, so it is more difficult to find strokes to save. The same can be said for the Fed and its battle against inflation. It’s a lot easier to shave two or three percentage points when inflation is at 10%, than when it’s at five percent. In June 2022, official inflation peaked at 9.1%. Today, Core CPI is about four percent. In other words, the easier part of the Fed’s job is done. However, shaving the last two percent off inflation will be difficult. Wages are still growing, homes are not getting cheaper, food costs are still rising, and healthcare costs continue to march higher. Also, the stock market’s strong 2023 performance has left investors with more disposable income. In the past, it usually took a recession to get inflation back to its baseline number. Either way, inflation has to keep falling, otherwise, we will have to brace for the possibility of a 1970’s style start/stop Fed rate hike campaign, and that would be the absolute worst-case scenario for stocks and bonds.
Bottom Line: The Fed has cleared a path for the market to continue to rally but don’t confuse this market with one that doesn’t have risks because, at this point, if economic growth rolls over in 2024, the Fed will be largely powerless to help. Pivots only work once. And the Fed just used it.
2024 OUTLOOK…
As we enter 2024, the two main questions that need answering are:
1.) Will inflation continue to fall towards the Fed’s 2% goal?
2.) Will the U.S. economy stick a soft landing? (Slower growth, but still growing)
At the moment, the big risk is that all the good news is already priced into the stock market. Any surprises are more likely to be on the negative side. For example, the Fed has indicated that it expects three cuts this year, yet markets are expecting six to eight cuts. This wide disparity in expectations leaves the market vulnerable to disappointment. Additionally, the dovish Fed decision still doesn’t address the major question facing markets that likely will define 2024 performance: Is the economy experiencing a mild slowing of activity or is this the start of a real, larger-than-expected slowdown? If it’s the former, then the dovish stance by the Fed and anticipated rate cuts will likely spur a continued rally in stocks. If it’s the latter, and the economy experiences a hard landing, then the euphoria over a dovish Fed pivot will be misguided because the Fed will be too late and markets will have to acknowledge a real economic slowdown and reprice equities. At these levels, that could easily result in a 15% - 20% decline in the S&P 500 (this would essentially be a repeat of what happened in 2000 and 2006 when the Fed cut, markets rejoiced, only to later realize that the slowdown had already begun).
Bottom Line: Markets, in our opinion, have aggressively priced in no recession or slowdown, but that’s premature. The economy could easily slow and there are some signals slowing growth is happening. For this rally to continue, we can’t have economic data suddenly start to miss expectations. That’s why we’re watching economic data closely at the start of the year. Additionally, it’s not clear what happens with corporate earnings. Frankly, they haven’t been very good over the past quarter. Hopes of Fed rate cuts have helped investors ignore that fact, but the reality is that if earnings start to falter, that’s a problem at these valuations and the Fed can’t help that, either. So, we’ll also be watching earnings very closely starting the third week of January. If economic data stays resilient and earnings hold up, then absolutely this rally in stocks can continue and the S&P 500 will likely move to fresh all-time highs. But again, that’s not dependent on the Fed. It’s dependent on economic data and earnings and those will be the key variables for markets as we start the new year and that’s exactly why we’ll be monitoring both so closely in the coming year.
Quarterly thought…New Year
“Every year you make a resolution to change yourself. This year, make a resolution to be yourself.”
…Unknown
May all your dreams come true in the new year.
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*The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
* The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
