“An economist is an expert who will know tomorrow why the things he predicted yesterday didn’t happen today.” –Evan Esar
We’re now a couple weeks into 2024, and the S&P 500 just finally eclipsed its prior all-time record high reached back on January 3rd, 2022. After a brutal 2022 for markets, last year was another stark reminder of the danger of investing based on the tea leaves of Wall Street economists and price forecasters.
It has been anything but an easy task to remain invested over the last two years as there have been a number of events that have caused investors angst and uncertainty.
- Inflation not seen since the 1970s
- The Russia/Ukraine war
- The uncertainty of China’s slowing economic growth
- The Israeli-Hamas conflict and unrest in the middle east
- The sky high debt levels and vacancies in the commercial real estate market
- The failure of Silicon Valley Bank and ensuing banking crisis
Heading into 2023, the consensus across Wall Street was for one or several of the previously mentioned events to cause anywhere from a severe to mild recession to hit, resulting in another year of below average market returns. However, last year ended up serving as a reminder of why the best course of action continues to be sticking with a sound plan through the rollercoasters of the market’s ups and downs.
THE PERILS OF FORECASTS
The average of 41 Wall Street forecasters from a Reuters article near the end of 2022 was for a 6.6% gain in 2023 for the S&P 500 index. This was well below the final price gain of 24.2%.
Former Wall Street banker turned financial blogger, who goes by the name “Financial Samurai,” did a nice job summarizing some of these predictions in a recent post. Here are snippets of commentary he pulled from various market forecasts from some of the most well known Wall Street firms heading into 2023. You can see the price predictions for the S&P 500 prior to the start of last year were all over the map. The lowest of the well known firms was from Morgan Stanley at $3,900 and the highest price target from Deutsche Bank at $4,500. Even the highest forecast was still almost 7% below the eventual year end closing price of 4,769.83.
NEGATIVE/BEARISH 2023 S&P 500 FORECAST
- Morgan Stanley: 3,900, $195 EPS (as of Nov. 14, 2022) “This leaves us 16% below consensus on ’23 EPS in our base case and down 11% from a year-over-year growth standpoint. After what’s left of this current tactical rally, we see the S&P 500 discounting the ’23 earnings risk sometime in Q123 via a ~3,000-3,300 price trough. We think this occurs in advance of the eventual trough in EPS, which is typical for earnings recessions.“
- BlackRock: 3,930, $231 EPS (as of Dec 17, 2022), “0.0% real GDP growth 2023, 2.9% Core PCE Inflation 2023, Overweight Energy Services, Healthcare Providers, Infrastructure, Underweight Consumer Discretionary”
NEUTRAL 2023 S&P 500 FORECAST
- BofA: 4,000, $200 EPS (as of Nov. 28, 2022) “But there is a lot of variability here. Our bull case, 4600, is based on our Sell Side Indicator being as close to a ‘Buy’ signal as it was in prior market bottoms – Wall Street is bearish, which is bullish. Our bear case from stressing our signals yields 3000.“
- Goldman Sachs: 4,000, $224 EPS (as of Nov. 21, 2022) “The performance of US stocks in 2022 was all about a painful valuation de-rating but the equity story for 2023 will be about the lack of EPS growth. Zero earnings growth will match zero appreciation in the S&P 500.“
POSITIVE/BULLISH 2023 S&P 500 FORECAST
- JPMorgan: 4,200, $205 (as of Dec. 1) “…we expect market volatility to remain elevated (VIX averaging ~25) with another round of declines in equities, especially after the run-up into the year-end that we have been calling for and the S&P 500 multiple approaching 20x. More precisely, in 1H23 we expect S&P 500 to re-test this year’s lows as the Fed overtightens into weaker fundamentals. This sell-off combined with disinflation, rising unemployment, and declining corporate sentiment should be enough for the Fed to start signaling a pivot, subsequently driving an asset recovery, and pushing S&P 500 to 4,200 by year-end 2023.“
- Deutsche Bank: 4,500, $195 EPS (as of Nov. 28) “Equity markets are projected to move higher in the near term, plunge as the US recession hits and then recover fairly quickly. We see the S&P 500 at 4500 in the first half, down more than 25% in Q3, and back to 4500 by year end 2023.“
I highlight this to show even the largest Wall Street firms, with the most highly “skilled” forecasters and analysts in reality have no idea how stock markets are going to perform over the short term.
We should therefore take any forecast or prediction of short term stock market performance with a heavy dose of skepticism, especially since these firms make massive amounts of money when trading volumes pick up in unsteady markets.
WHERE DOES THIS LEAVE US HEADING INTO 2024?
Regardless of what has happened in the past, I always want to give my best explanation of what we are currently seeing in the economy, with the caveat that the continuous ebb and flow of different factors make it nearly impossible to give an accurate state of the economy at any given point in time.
As we have also seen, financial markets and the economy don’t work perfectly in alignment, and the stock market tends to be a leading indicator. Meaning the outperformance of the stock market over the course of the year, compared to consensus estimates at the start of the year, is much easier to explain in the rearview mirror.
Over the long term, I believe company profits/earnings will continue to be the best indicator of where the stock market is headed long term. There are all sorts of factors that impact the ability of companies to generate profits. Regardless of any political views, one thing that 2023 showed us for sure is that large corporations are extremely resilient when it comes to generating profits even under difficult and uncertain financial conditions. I continue to believe that a bet on the US stock market or global financial markets in general is a long term bet that collectively corporations will continue to find ways to generate growth in profits.
WHATS THE DATA SAYING
There are a thousand different data points we could look at on the economy, so I am going to zero in on three that I think will be the most impactful on company profits and therefore may have the most impact on financial markets in the year ahead. This is not attempting to predict a price target for the market this year, but rather to give a balanced view on why I remain optimistic about financial markets for 2024.
CONSUMER SPENDING
US personal consumption expenditures (consumer spending) makes up almost 70% of Gross Domestic Product (GDP) which is the primary metric used to measure economic activity. This means that the consumer is the primary driver of the overall economy.
Positive factors – US household net worth remains near an all time high. Even though overall consumer debt levels have also reached all time highs, the actual debt capacity of consumers, or the margin they still have to continue to take on debt to fund spending remains near all time lows. I believe this means that as long as people still have jobs they will continue to fund their spending by increasing their debt load, even as we see the overall household savings rate decline. The job market continues to be strong with unemployment under 4% and wage growth now above the rate of inflation. In summary, these factors show the average consumer, although battered by inflation the last two years, still has a willingness and capacity to spend.
Negative factors – The impact of the student loan repayments in October will mean less disposable income for the large number of consumers carrying student loan debt. It will remain to be seen how consumers will prioritize making the payments on these loans. Rising interest rates have also made overall access to credit tighter, especially in light of the banking struggles we saw in 2023 and a hesitation to lend. This could be a negative on consumer spending, if there is a reduction in consumers ability to access credit.
CORPORATE PROFITS
We did not get the recession most economists were predicting in 2023, but there was definitely a slow down in corporate earnings growth. As mentioned before, I believe long term corporate profits/earnings are what ultimately drive stock market returns.
Positive factors – The resilience of the consumer and labor market is helping to drive continued spending. In the face of inflation, corporations passed on large price increases to consumers. Regardless of political views, the ability of corporations to raise prices when there is inflation, makes stocks/equities a great long term hedge against inflation. Consumer spending impacts the top line (revenue) but inflation and productivity impact the bottom line (earnings/profits). Many large companies were able to lock in long term debt at historically low levels, and are now earning a spread above the interest payments they are making on that debt, just from the cash sitting on the company balance sheet. The advancements in AI technology are predicted to add to productivity also benefiting the bottom line for corporations. Last year we saw one of the first consumer facing uses of AI with the introduction of ChatGPT. AI and other technological advancements in general will continue to increase efficiencies for companies and also act as a continued deflationary force to the economy as a whole.
Negative factors – Overall combined earnings per share on the S&P 500 rose from 219.49 in 2022 to 219.70 in 2023. This means that earnings growth on the S&P 500 was only 0.10%, while the price was up over 24% last year. This shows that nearly all of the gains from the past year were driven from multiple expansion (price expansion) and not from earnings growth. To put this another way, the price to earnings ratio on the S&P 500 rose from 17.49 at the beginning of 2023 to 21.71. This shows that collectively investors in the market are much more optimistic about future earnings growth. A big risk factor heading into 2024 is the earnings growth doesn’t materialize with stocks already priced much higher than a year ago at this time.
INTEREST RATES, GOVERNMENT DEBT AND DEFICIT SPENDING
The rapid rise in interest rates was a huge topic during 2023. This hit interest rate sensitive sectors of the economy like real estate and banking particularly hard. We saw a handful of large bank failures and are still waiting to see the longer term impact the decline of the commercial real estate market will have on lenders who hold a large amount of this debt. The rise of interest rates has made it harder for consumers and businesses to borrow, which could slow consumer spending (but this has not been the case for the government).
Government debt levels continue to climb to all time highs quarter after quarter, even in a strong economy with a tight labor market. During times of positive GDP growth we would ideally be running budget surpluses, whereas the federal government is still currently running at huge deficits.
Positive factors – Short term the budget deficits are stimulating the economy through fiscal spending policies. Everyone was asking the question “why didn’t the economy crash, as the federal reserve raised the fed funds rate by over 5% to fight inflation.” New legislative policies passed by congress like the Inflation Reduction Act, included heavy doses of fiscal spending which have continued to stimulate the economy, acting as an offset to tighter monetary policy from higher interest rates. Now heading into 2024 the narrative has shifted to talk of the Fed beginning to cut short term interest rates within the next few months. This still remains to be seen, but there at least seems to be consensus among Fed officials that any further interest rate increases are off the table.
Negative factors – Long term, the ballooning federal debt levels and deficit spending are alarming. The debt service payment levels will continue to become a larger percentage of GDP, meaning less money to spend on other areas to continue to grow the economy. Currently the government just continues to fund new initiatives and support current obligations (social security and medicare) through the issuance of new debt. US debt is held by a large number of borrowers and as long as there is still a huge appetite for our debt and the US dollar as a reserve currency, this should not be an issue. I think it would be extremely difficult to try to place a time horizon on when the debt levels may become a bigger issue, as people have been sounding the alarm on this since debt levels started to spike after the great recession of 08-09 and the ensuing initial US debt downgrade in 2011. If you moved to the sidelines then, you would have missed out on over ten years of 10% annual returns for the stock market.
ALIGN YOUR INVESTMENTS WITH YOUR FINANCIAL PLAN
Last year served as a reminder about how hard it is to predict stock market performance. I understand there is no shortage of articles out there vying for attention with clickbait headlines, so I think it is always important to provide data about how the overall economy is performing and current opportunities and risks I see in the current investing environment.
The rise in the market last year was almost 100% due to price appreciation and not earnings growth. However, I believe the drop in inflation and continued strength in the job market should continue to support consumer spending which could in turn support a rebound in earnings growth.
Historically, the market has been positive on a one year basis around three out of every four years. The market has also historically followed up a large positive year of performance more frequently with another year of positive performance. So, while there are no guarantees when it comes to investing, the odds favor staying invested even after a strong year of performance.
When I am talking about the “market” I have just been using the S&P 500 for reference. There are other asset classes like small cap stocks and international stocks that continue to trade at a discount to their historical price multiples. I continue to think this means sticking to a diversified investing plan and rebalancing will pay off over time, as other asset classes outside of US Large Cap Stocks could be due to play catch up in the year ahead.
It also means creating an investment portfolio that is aligned with your overall financial plan. When markets get choppy again in the future, which they undoubtedly will, having a plan in place helps you to make decisions based on the objectives laid out in your plan. This helps you avoid making decisions based on the emotions created by the media and markets.
