After big storms there is always damage. As the hurricane of historically high inflation and central banks' rate-rising campaign dissipates there has been significant damage done across most stocks, bond funds, real estate and investor’s appetite for risk. Although market indexes looked healthier in 2023 – most of the early advance was driven by the Magnificent Seven Artificial Intelligence (AI) technology stocks, which make up a disproportionate percentage of these proxies. The average stock in the indexes (the other 493 stocks in the S&P 500) and market as a whole were up slightly or, in many cases, down for the last two years in a row. The valuations or price-to-earnings ratios in majority of global markets are at reasonable, if not bargain levels. As the skies are now clearing, this spells “OPPORTUNITY.” Let’s dig in and survey the aftermath of the storm for what we see as the winners of 2024 and beyond.
Equity Markets Outlook
Whenever global economies and financial markets find themselves in disequilibrium, as they were two years ago in early 2022 due to runaway inflation, we would expect a traditional bear market in financial markets – averaging an 18-month period. The most recent two-year bear market was a “textbook” example as most stocks slid 30-40%, many bond funds slipped over 20%, and Real Estate Investment Trusts (REITs) declined more than both. Bear markets end when economies and markets find their way back into equilibrium – as is the case now with inflation closer to 3% and stock prices at attractive levels. This is the ideal set up for the new business cycle and bull market we envision over the next 5-8 years. A different kind of business cycle and bull market, but one that will be generous for astute investors.
As we enter this new business cycle and coinciding bull market investors must realize that it will be a period when interest rates will remain higher than the last cycle. This has important implications for certain sectors of the stock and bond market. It will also be an economic cycle and bull market that will benefit from the tailwinds of the important transformational changes in technology through AI. The AI transformation has many important and positive implications for the global economy to exhibit higher-than-normal productivity and corporate profit growth – these are very bullish metrics for global stock prices.
Many investors have been surprised by the resilience of economic growth both here and abroad given the aggressive rate hikes by central banks over the past two years. We would suggest that much of this resilience stems from the infusion of fiscal stimulus during the period. Regardless, we are now at a point of economic stability coupled with manageable inflation and global central bank neutrality. Corporate profit growth for 2024 looks healthy as companies “get back to business” and cease worrying about the Fed raising rates further and the headwinds of inflation. We are also entering this new business cycle and bull market at a point when corporate balance sheets are healthier than they have been in many years. We also think most stocks are currently undervalued, which, alongside these economic metrics, provides strong further proof that we have a great set up for a new bull market.
As a reminder, business cycles and bull markets last for a long time – think years not months. In fact, the average bull market is about 7 years and global stock indexes often triple during these extended periods. The storm has passed and there is much brighter weather ahead!
We know that there are many issues which could derail our optimism about this bull market and business cycle. Geopolitics, a return of inflation, a recession, or some other unknown “black swan” event, just to name a few. However, unlike the last two years, we are now confident that the Federal Reserve and other central banks are willing and able to lower interest rates should we run into any of these known or unknown risks. This potential easier monetary policy can go a long way in supporting the continuation of the bull market and business cycle.
Fixed Income Outlook
It’s finally a great time to be a fixed income investor. In our view, interest rates have peaked making bond purchases of short, intermediate, and long maturities very attractive. Not only are we locking in higher yields than we have seen in more than a decade but we will also be benefiting from bond price appreciation if interest rates moderately decline. This combination of higher yields and prices should be a great benefit for bond investors in 2024 and beyond.
Real Estate Outlook
As interest rates have peaked, this should mark the end of the bear market in most of the REIT market as well as defrost the frozen residential real estate market. Any decline in interest rates will reduce the debt payment burden for REITs and restart purchases, as mortgage rates fall from their 8%+ peak seen a few months back.
As we begin the presidential election year, we understand this can cause investor confusion and caution. Historically, election years can cause some volatility, but who is elected very seldomly affects the global stock market. However, the volatility in election years can often create risks and opportunities in certain market sectors – such as healthcare or industrials. We will be watching the election race closely with this perspective in mind.
It is a relief to see the global economy and financial markets return to equilibrium and the metrics for both in a great position for investors in global stocks, bonds, and real estate. The recent Santa Claus “melt up” in stocks has been very welcome and we think is a precursor to the better period ahead we envision. However, as we enter the New Year, it would not surprise us to see a normal correction (8-14%) of these gains. Investors should take advantage of these normal pullbacks to add stock exposure or tilt portfolios to the most attractive sectors – we certainly will be.
As you know, even at our most optimistic we are always aware that factors beyond our knowledge can disrupt our positive stance with your portfolio. Our Active Risk Management process is uniquely positioned to assist us in managing these more difficult periods of abnormal market decline - as it has in 2008, 2020 and 2022. Keep in mind that this process is not meant to eliminate the normal market volatility of index swings. Our Active Risk Management process is intended to mitigate the risk of the catastrophic loss that comes with traditional bear markets. As we enter this exciting new business cycle and bull market, we will have this process in place during the journey.
We hope you find this update helpful as we start the new year. Please let us know if you have experienced any changes in your finances or would like to discuss your portfolio. Additionally, if you have a family or friend who would like to learn more about how we can help them benefit from this new profitable period for financial markets, please feel free to refer them to us.
Thank you for your vote of confidence in our work, and a Happy New Year from all of us!
Your Main Street Research Team