This article is from our Outlook 2024 edition of MarketWatch.
26th January, 2024
If rate expectations are as powerful a force in 2024 as they were in 2022-23, and if we are right that the market is overestimating US rate cuts, then what will happen when the market realises this? From August through to October 2023, the stock market fell by 11% on the realisation that Fed chair Powell was serious about ‘higher for longer’.
A simple answer is that we’re long-term investors, and as long as inflation is beaten and rates eventually come down, we can handle some near-term volatility. Looking at previous 12-month periods post-Fed rate peaks, returns were typically strong (see Figure 3). Economic backgrounds were different then, and markets have already rallied since the Fed last hiked in July, but history does suggest that the return odds are stacked in favour of stocks and bonds once the Fed stops hiking.
It shouldn’t surprise readers to learn that we don’t believe we can time the market to within 1-3 months, and therefore we’re not inclined to follow such strategies. But it’s worth noting that even if our timing is less accurate than this, there were still circa 25% of times when exiting the market would have been the right move. What are the chances that 2024 is one of these episodes?
The periods when exiting the market were clearly successful are perhaps the obvious ones – the oil shock and bear market in 1974, the 2000-2002 tech crash and the global financial crisis in 2008. Other marginal cases where imperfect timing was just about profitable were Black Monday in 1987, the China and energy slump of 2015, and the inflation-induced bear of 2022.
At the risk of sounding complacent, with inflation coming down and the financial system more tightly regulated, the set-up in 2024 does not resemble 1974, 2008 or 2022. If anything, the recent enthusiasm for the Magnificent Seven2 may remind some investors of the late 1990s. But while the dominance of such a small group is unusual, we note that these companies are mostly cash-rich and highly profitable. Of more concern is the recent resurgence in more speculative stocks.
To put market levels in perspective, we compare valuations with the 1990s bubble period. At over 20x forward earnings, the S&P 500 is expensive, although cheaper than it was in 2020-21. But we can see that this is led by the technology sector at 30x earnings, while the average US stock trades at roughly 18x. So the market is not cheap, but not as expensive as it looks on the surface, and nowhere near the levels of the late 1990s.
Warning: Past performance is not a reliable guide to future performance. The value of your investment may go down as well as up. These products may be affected by changes in currency exchange rates.
Warning: Forecasts are not a reliable indicator of future performance.