As usual, there is no shortage of talking points, some of which don’t change from one year to the next. A few are continuations from 2023, while every new year offers endless chances for surprises. December of each year is filled with specific projections from a variety of firms; the accuracy of such calls is not often measured but tends to not be that great. This is merely a list of issues that could affect market sentiment.
- Fed and interest rates. In 2023, most of the focus has been on how far and how long the Fed will keep tightening policy in place. Now that we’re at an apparent pause, the question now has turned to how long the pause will last and when the first-rate cuts will happen, and, if so, how deep the easing will go. This is obviously hinged on several other factors below. While Chair Powell’s press conference was taken dovishly, that the Fed would be open to discussions of cuts, this was taken more seriously by markets, requiring some pullback by several members of the Fed in their speaking circuit—noting that markets may have gotten ahead of themselves by expecting cuts soon. Conditions look to be increasingly well-balanced, which is what the Fed has been aiming for. Regardless of when cuts come, the days of zero-interest rates are likely behind us. That period was in response to an extraordinarily deep economic downturn and financial system distress, while it has been acknowledged that using such low rates to ‘bail out’ a normal downturn is imprudent and dangerous. Low rates for too long can generate and sustain asset bubbles, which have historically ended badly. A moderate drift lower toward a more balanced rate policy would be the less disruptive and likelier option. Rates staying high for longer could pressure financial conditions, and weigh on growth, while cutting would ease conditions and could be celebrated in both stock and bond markets—assuming the conditions requiring cuts aren’t catastrophic.
- Inflation. This has been a headline concern over the past few years, with mid-2023 finally showing progress back toward normal. In fact, even though levels haven’t fallen back completely, some commentators are now describing inflation as ‘old news.’ Supply disruptions from the pandemic are over, although the shocks from that period coupled with other political trends have pushed many countries to ‘re-shore’ or ‘friend-shore’ more critical industries. While making inventories more resilient, it could also prove less efficient and raise costs compared to the past few decades when manufacturing in the lowest-cost locations was a top priority. Financial balances (such as M2) which spiked during the pandemic have also retreated, as the Fed winds down its balance sheet. There is a difference between higher prices and inflation, though. Inflation is technically defined as the rate of change in prices—the part that has finally shown deceleration, which is a positive. However, inflation over the past few years resulted in a higher price plateau for a variety of goods, including food, cars, and other items in consumer shopping baskets, as well as services—all of which may have kept consumer sentiment more negative than it might otherwise be.
- U.S. economic growth vs. recession. Another key question has been resolution of the ‘recession’ or ‘soft landing’ debate. Unfortunately, the answer is still yet to be determined. We know from history that recessions are inevitable and unavoidable, as normal parts of the business cycle. The wildcard is the timing (over the last century it’s been every 5-6 years in the U.S.). Technically, back-to-back declines of GDP in Q1-2022 (-2.0%) and Q2-2022 (-0.6%) could have been defined as a recession using purely quantitative rules of thumb, but the U.S. NBER dating committee didn’t elect to formally classify it that way. Will we finally get a recession in 2024? Or more waiting until 2025 or 2026? The past has shown us that the unforeseen can cause a recession out of nowhere, such as an extreme oil price shock, war, or pandemic.
- Global economic growth vs. recession. Europe and the U.K. have been on the precipice of recession for months, along with fighting higher inflation, at least until recently. That combination narrowed the room for policy error. Financial market valuations appear to be pricing in the negativity. In Asia, Chinese activity has been hampered since the re-opening from the pandemic with a substantial real estate debt overhang. However, the government appears to be careful in not overstimulating areas it does not want to reward and reinflating speculative excesses. Technology and trade tensions with the U.S. also bring uncertainty, as both sides have generally benefitted from the economic relationship over the last several decades, which could be tricky and expensive to decouple. While emerging markets broadly have provided lackluster results in recent years (again priced in, along with poor sentiment), pent-up demand returning to more normal growth levels could act like a coiled spring.
- Earnings. Longer-term, this tends to be the primary driver of stock market returns. Earnings reflect a variety of inputs, starting with incoming revenues, which have been related to global economic growth. They also depend on costs, which inflation has affected, in commodity prices until recently and higher employee wages. However, profit margins remain quite high (over 10%, nearly double levels of 20 years ago), partially from the more efficient and less capital-intensive nature of today’s market basket, which contains more tech and communications, and fewer industrials, for example. Per FactSet, expectations for 2024 S&P 500 earnings growth are running around ~12%, which is seen by some observers as too optimistic, but does point to bullish expectations generally.
- Elections. U.S. Presidential elections tend to flare emotions, but ultimately, political parties or administrations in charge have mattered little to financial market returns. From 1926-2022, per Morningstar and FPS calculations, the third year of a Presidential election cycle (2023 is one) has been the strongest-performing, with average annual returns of 16.7%. The second best is the election year itself, at 10.2%. In the short term, market results can even run the opposite of what is first feared, as ‘status quo’ in policy has tended to be the norm as opposed to immediate extreme changes, not to mention ‘relief rallies’ (with election uncertainty simply being over). What markets could react to a bit are changes at the fringes that affect economic growth, global competitiveness/trade, fiscal policy, or tax levels, although such movements haven’t been overly persistent historically. Looking globally, nearly one-half of the world’s population lives be in countries holding elections in 2024, which contains more potential for unpredictable outcomes, especially in emerging markets.
- Geopolitics. This is the usual wildcard that could go in any number of directions. The highest odds remain where conflicts are either ongoing or routinely erupt, such as Russia/Ukraine, Israel/Gaza, and now the Red Sea. Naturally, a variety of other tensions are ever-present, involving Iran, China, and others. Aside from military conflict, disruption of commerce or commodity supplies have often been the first assets affected—crude oil is one that has commonly responded first. Now that bonds offer a higher, more historically-normal yield, it would not be surprising to see U.S. treasuries see even more popularity as a safe haven if risks rise. That function has tended to outweigh all other near-term concerns (fiscal situation, etc.) in times of crisis.