Slivers of sunlight have finally pierced through the clouds in America, as the nation’s gross domestic product grew by an annual rate of 3.3% in the fourth quarter of 2023. That news should help the U.S. stock market, which has gained 1.6% as measured by the S&P 500 index on a year-to-date basis. And it’s not just the S&P 500. The Dow Jones Industrial Average closed above 38,000 for the first time on Jan. 25. Meanwhile, the Nasdaq Composite saw its highest close (15,628.04) in two years on Jan. 29.
On the downside, consumers are still fretting over high prices at grocery stores, though costs are expected to tick downward in 2024, according to the U.S. Department of Agriculture. Overall, food prices rose 2.7% from December 2022 to December 2023. Household kitchen staples like eggs and lettuce have declined in price, but beef and sugar prices rose from 2022 to 2023.
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Factor in still-record-high home prices, labor volatility that’s led to tens of thousands of layoffs so far in 2024 (U.S. technology companies have already laid off nearly 30,000 employees this year) and stagnant wages, and the American consumer isn’t raising any champagne glasses to the U.S. economy in early 2024.
What does that mean for the U.S. stock market, which seems to be on the upswing this year? So far, it means continued uncertainty leading into a volatile U.S. presidential election season and more household finance angst in 2024.
“Views are mixed on the outlook of the stock market in 2024,” said Steve Crews, a Calgary, Alberta-based mortgage lending specialist and founder of Golden Road Reborn, a global stock market trading system. “Some traders predict a flat or down market in the first half of 2024 due to high inflation, recession fears and rate hikes from the Fed. However, others foresee a bull market continuing, citing potential Fed rate cuts, earnings growth and historical trends around election years.”
What are the key facts that could move the markets into deeper waters in 2024? Here are six keystone issues that could impact the financial markets this year:
1. High stock valuations.
2. Overdependence on leading stocks.
3. Interest rate expectations.
4. Consumer exhaustion.
5. Stubborn inflation.
6. The presidential election.
1. High Stock Valuations
While valuations
are stretched versus long-term S&P 500 averages (currently selling at 19 times next year’s earnings, compared to a 55-year average of 16), interest rate fluctuations should drive stocks in 2024 — if they head in a certain direction.
Excessively high valuations could lead to a problem with stock performance for the rest of 2024.
“The S&P 500’s current forward price-to-earnings ratio is around 20, compared to about 17 at this time last year,” Lisa Shalett, chief investment officer at Morgan Stanley Wealth Management, wrote in the company’s Jan. 8 investment committee weekly report. “Meanwhile, the ‘equity risk premium’ — i.e., the reward an investor can expect for owning stocks over risk-free Treasurys — is at an extreme low of about 1 percentage point.”
If you stretch the current valuation outlook along to the end of 2024 and into 2025, you can get a more accurate predictor of returns. “On that score, today’s valuation levels point to subpar annual stock returns, with gains averaging 4% compared to the long-run average of 7% to 8%,” Shalett said.
2. Overdependence on Leading Stocks
The so-called “Magnificent 7” — Alphabet Inc. (GOOG, GOOGL), Amazon.com Inc. (AMZN), Apple Inc. (AAPL), Meta Platforms Inc. (META), Microsoft Corp. (MSFT), Nvidia Corp. (NVDA) and Tesla Inc. (TSLA) — were undisputed victors in 2023.
The Bloomberg Magnificent 7 Total Return Index returned 107% in 2023 compared to the S&P 500’s 24%, primarily due to upbeat company fundamentals for the major technology companies for the year, as noted by David Polak, equity investment director at Capital Group, in recent commentary.
“These companies not only benefited from their early investments in artificial intelligence, they also helped drive the S&P 500 higher, since the index is weighted by market cap,” said Kelly Milligan, managing partner at Quorum Private Wealth in Danville, California.
There’s just one problem: Most of the overall stock market gains last year were derived from the Magnificent 7 stocks. Any deviation from that performance could lead to market underperformance in 2024.
3. Wishful Thinking on Interest Rates
Investors may be counting on the Federal Reserve to aggressively curb interest rates in 2024, but Morgan Stanley’s Shalett believes that may be wishful thinking.
“The market continues to assume that the Fed will cut rates more quickly and steeply than it has publicly signaled,” she said. “Despite the Fed’s signaled intent to cut rates three times this year, futures markets are pricing more than six. That assumes the central bank will enjoy an uninterrupted victory in taming inflation, whereas we believe inflation in labor-intensive services is still likely to persist.”
[READ: Recession 2024: What to Watch and How to Prepare]
4. Consumer Exhaustion
U.S. credit card users are digging a deep hole with plastic debt. Credit card delinquencies were up across the board in the third quarter of 2023, according to the Federal Reserve Bank of Philadelphia. Those delinquency figures encompass credit card debt that’s 30, 60 and 90 days past due, the Philly Fed reported.
Additionally, consumer non-mortgage interest payments have risen by 50% on a year-to-year basis, cresting $1 trillion in Q3 2023, according to the U.S. Bureau of Economic Analysis.
“The burgeoning ‘living beyond means’ character of the consumer can most easily be seen when looking at consumers’ revolving credit … and the associated increase in serious credit card delinquencies,” Charles Schwab investment strategists Liz Ann Sonders and Kevin Gordon wrote in a recent research report. “Those delinquencies are particularly acute among younger borrowers. For now, healthy wage growth has kept the ratio of credit card debt to compensation historically low; but further weakening of wage growth will cause the ratio to climb.”
Downbeat consumer sentiment could weigh heavily on stocks, given that consumer spending accounts for about 70% of GDP, Sonders and Gordon noted.
5. Stubborn Inflation
Currently, the U.S. inflation rate as measured by the consumer price index (CPI) stands at 3.4%, with the Fed noting that inflation should fall below 2.5% in 2024 — still above the Fed’s 2% target rate. It’s worth noting that the Fed’s preferred measure of inflation is the personal consumption expenditures (PCE) price index.
Some economic experts point to the ties between worker wages and inflation, which remains high in early 2024. As U.S. Bank notes, average hourly earnings growth remains above 4%, which is “still higher” than the Fed prefers.
“If we look at the Fed’s definition of progress on inflation, (the Fed wants) to get it closer to their target of 2% per year,” says Eric Freedman, chief investment officer at U.S. Bank Wealth Management. “The question is how much further inflation must level out before the Fed is again willing to change course on interest rates.”
6. A Roiling 2024 Presidential Election
With the Republican Party set to nominate former President Donald Trump and the Democratic Party circling the wagons behind an unopposed President Joe Biden, the 2024 election season has landed.
Given that polling numbers are down for both candidates, that landing shows more “thud” than “bounce” — and that’s a big issue, given history shows that major election years have a significant impact on the financial markets.
“Going back to 1980, stocks have rallied in the year following an election, on average,” says Greg Sweeney, chief investment officer at Bell Bank in Bloomington, Minnesota. “So while volatility may pick up with the unknown heading into an Election Day, stocks tend to forge ahead as uncertainty fades.”
While the Fed is hitting the brakes on rate hikes (and yields tend to fall pretty quickly when that scenario occurs), market volatility already exacerbated by the election could be further triggered.
“This means cash carries reinvestment risk, and today’s elevated bond yields offer an opportunity to lock in higher income potential for longer,” J.P. Morgan Wealth Management investment strategists Madison Faller and Shawn Snyder said in a recent research note. “We’re most excited about municipal bonds, with their tax treatment offering an even bigger pick-up in yield alongside limited default risk.”
Steps to Crash-Proof Your Investment Portfolio in 2024
Despite the Fed’s “higher for longer” interest rate strategy that could hamper business and consumer finances in 2024, U.S. financial markets seem headed for a smooth landing this year.
“We aren’t as confident about that, but we still see opportunities in a total-portfolio context,” Kate El-Hillow, Russell Investments’ president and chief investing officer, noted in the company’s 2024 Global Market Outlook. “Government bonds look valuable as yields exceed inflation and could become more appealing as a hedge against stock market volatility. We prefer quality equities for their relative value and defensive characteristics.”
Real estate investment trusts, or REITs, and global listed infrastructure are also attractive and “should benefit from longer demographic and technology trends,” El-Hillow said. Consumers should also focus on asset allocation as the year proceeds, as portfolio diversification and active management are big issues in what could be a volatile 2024 financial market landscape.
“This goes beyond stocks and bonds and addresses broader macro factors such as inflation, growth and trade,” El-Hillow noted. “Next-generation diversifiers such as real assets and private credit offer additional benefits in this context. As monetary policy changes, diversification within the growth side of portfolios will become more relevant, but elevated volatility will make it critical to be selective.”
Investors should also pay attention to stock market breadth, one of the most important developments to watch in 2024 (i.e., the number of market indexes, sectors, styles and individual stocks that are participating in the stock market’s uptrend.)
“At the end of the third quarter of 2023, small-cap, mid-cap and the average U.S. stock were all down year to date, while the S&P 500 and Nasdaq were up largely due to their concentration in a small number of large-cap growth stocks,” said Thomas Samuelson, chief investment officer at Vineyard Global Advisors in Castle Rock, Colorado. “The encouraging development in the fourth quarter of 2023 is the rallies being seen in small-cap, mid-cap and the average U.S. stock, foreign developed and emerging stocks.”
“This is healthy and needs to continue,” he adds. “A bull market supported by a handful of stocks can only last so long.”
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Update 02/01/24: This story was previously published at an earlier date and has been updated with new information.
