Heading into 2023, the consensus of forecasters called for a recession and puny stock market results in the face of substantial headwinds from higher interest rates. Boy was that wrong. In fact, the economy grew around 2.5%, the S&P 500 gained 24%, and the tech-laden NASDAQ Composite soared by 43%, driven largely by the hype around artificial intelligence. Given how amiss the conventional wisdom proved to be, prognosticators are considerably more circumspect and their forecasts more diverse entering 2024. Individual investors, on the other hand, enter the year more bullish than any time since early 2021, an often-reliable contrary indicator. Either way, investors should take time to review and adjust their portfolios to prepare for whatever is in store this year. Here are a few of the themes that may influence the markets.
Slowing economy. Consumers continued their post-Covid revenge spending in 2023, but for many, the well is running dry with mounting credit card balances, depleted savings, and the resumption of student loan payments. Consumers account for over 2/3 of GDP, so any weakening in spending will create a drag.
Business investment is also expected to remain sluggish as tighter financial conditions cause companies to delay expansion plans. The end of pandemic era supply chain disruptions will soon reveal whether the massive investment in warehouses and logistics since 2020 have created excess supply, while nearly $1.5 trillion in commercial real estate mortgage debt comes due over the next 3 years, including an ample stock of office properties with high vacancy rates.
Wall Street economists expect real GDP to expand by 1% to 1.5% in 2024, but most believe that the risk is to the downside, and many are still allowing for a 50/50 chance of a mild recession.
Labor market uncertainty. Although the number of job openings has declined since 2022, the US unemployment rate has remained remarkably low while participation has increased. With a slowing economy, expect more easing in labor shortages through 2024, with the unemployment rate creeping above 4% by the end of the year. In addition, a major factor that will begin to emerge is the impact of AI on employment as popular attention shifts away from the companies that power the technology to the employers that apply it at scale.
A recent report from Goldman Sachs predicted that generative AI applications like ChatGPT could conceivably assume 50% of the work currently performed by employees in many occupations over the next decade, beginning in 2024. Conversely, the report suggests a potential increase in productivity of 7%, boosting global GDP by 1.5 percentage points and creating whole new occupations not currently envisioned. Like all new disruptive technologies but perhaps even more acutely, the adoption of AI will create substantial dislocations and exacerbate income disparities, heightening the need for policymakers to proactively address retraining and support systems as well as regulatory responses to mitigate unintended consequences.
Stock market reset. Trees and portfolios do not grow to the sky. Individual investors who may have missed some of the gains from the Magnificent 7 have become excessively bullish over the past 2 months compared with statistical norms. Wall Street, however, is all over the map, with forecasts for S&P 500 returns ranging from a gain of 14% by Ed Yardeni to a loss of 11% from JP Morgan. Yet we can look at a few data points that argue for caution.
Expectations for future profits are a main driver of stock prices, and analysts are optimistic, predicting an average earnings growth of nearly 12% in 2024, double the annual average, even considering the headwinds from a tired consumer and the mounting geopolitical risks. A more reasonable 5%-6% profit growth would be a better bet.
Meanwhile, valuations remain high, especially among the mega-cap tech stocks. The S&P 500 is currently trading at 21.5 times next year’s expected earnings compared with the 30-year average of 17 times, not wildly overvalued but certainly constraining additional outsized gains this year. And investors remain excessively optimistic that interest rates will fall faster and sooner than is likely. The latest Fed meeting in December signaled a pivot, with the members of the Federal Open Market Committee anticipating 3 interest rate cuts of 0.25% each by year end if inflation continues to recede apace. Ever optimistic, the futures market is instead pricing in 6 rate cuts totaling 1.5% beginning in March, a most unlikely scenario with inflation still more than 1 percentage point above target. After earnings growth, interest rates are the next most important determinant of stock prices and investors are too optimistic.
How should individual investors prepare for the year ahead given the disparate forecasts? While it sounds cliché, diversification remains the optimal approach to long-term investing. Recall that last year, many pundits lauded the demise of the “60/40” portfolio and heralded the death of bond investing. Yet this asset mix turned in a near-record gain of over 12% during the last 2 months of 2023.
Rebalancing periodically is the key to a consistent all-weather approach. Given the outperformance of the mega-cap behemoths in 2023, many portfolios are overweight these stocks and consequently underweight the laggards including the traditional value plays like dividend payers, staples, financials, and energy that languished last year. Rebalancing now before the inevitable reversion to the mean is the best way to optimize performance over time, no matter whose forecast is correct.