2024 Stock Market Outlook | The Scholarch Research (2024)

2024 Stock Market Outlook: Year Of the Big Short

- Publication date: 01-27-2024

In our comprehensive stock market outlook for 2024, we closely examine the recent bullish trends in key indices. Both the S&P 500 and Nasdaq 100 have impressively broken above their January 2022 highs, signaling a strong upward momentum. This surge has significantly influenced the current sentiment for 2024, fostering a widespread belief in the economy's ability to achieve a soft landing.

However, our stock market outlook offers a critical counterpoint to this prevailing optimism. Despite the apparent strength in these indices, we present a case for caution. We delve into the nuances and underlying risks that may be overlooked in the wake of this market enthusiasm.

Our analysis takes into account various factors that challenge the notion of an uncomplicated economic path ahead. From the lingering geopolitical uncertainties to the paradox of significant layoffs in tech giants like Google amidst their strong financial performance, we explore elements that could potentially unsettle the current market trends.

This article endeavors to provide a nuanced analysis of the S&P 500, challenging the prevailing positive sentiment by highlighting its potential disconnection from the intricate geopolitical and economic realities. We urge our readers to delve into the insights featured in our stock market outlook, which underscores the necessity of adopting a strategic approach amidst these ostensibly bullish yet potentially misleading market scenarios for 2024.

Concluding this article, we share our strategy for the year, embodied in our strategic model portfolio. We believe this approach is optimally designed to outperform the S&P 500. We trust that you will find this article enlightening and beneficial as you navigate the financial landscape of 2024.

As we embark on an in-depth analysis of the stock market outlook, it's crucial to begin by evaluating the current health of the economy and the dynamics that have propelled it forward in the last three months. This evaluation forms the foundation for informed stock market predictions and offers insights into the S&P 500 and Nasdaq trends.

Economic Resilience and Growth Drivers

In recent months, the economy has demonstrated remarkable resilience, rebounding from earlier challenges. Key indicators have shown positive trends, reflecting a robust recovery trajectory. This resilience is primarily due to several critical factors:

- Consumer Spending: There has been a notable uptick in consumer spending, a cornerstone of economic strength. This surge is attributed to increased consumer confidence and the gradual return to pre-pandemic norms.

- Industrial and Technological Advancements: The economy has benefited from significant advancements in technology such as AI and industrial sectors. These developments have not only enhanced efficiency but also opened new markets and opportunities, positively impacting the S&P 500 and Nasdaq trends.

Stock Market Trajectory: Analyzing the S&P 500 Trend

Turning our focus to stock market predictions, the last quarter has seen impressive performances in major indices.This trend is reflective of the growing investor confidence in the market's future, buoyed by the economic recovery and tech corporate earnings.

Driven largely by the tech sector's resurgence and innovation, the Nasdaq's performance offers a glimpse into the market's appetite for innovative sectors and stocks.

As we project the stock market outlook for 2024, several questions arise. Can the current economic momentum sustain the bullish trends in the S&P 500 and Nasdaq? Are there underlying risks that might not be fully priced in by the market? Our forthcoming analysis will delve into these questions, offering a nuanced view of what lies ahead.

In this section of our stock market outlook, we delve into the intricacies of market internals, particularly highlighting the significant divergence observed between the S&P 500 and other key market indicators. This analysis is crucial for making accurate stock market predictions.

The Divergence between Large Caps and Broader Market

As of January 2024, both the S&P 500 and Nasdaq 100 have reached new all-time highs, marking a remarkable recovery after a two-year period. This rally, however, stands in stark contrast to the performance of small and mid-cap stocks, represented by indices like the S&P 400 and Russell 2000. This raises critical questions about the underlying market momentum.

- Small and Mid-Cap Stocks as Economic Barometers: Typically, smaller companies, such as those in the S&P 400 and Russell 2000, are considered more reflective of domestic economic growth. Their performance is often more closely tied to the health of US household incomes and the broader American economy, compared to larger, internationally-focused tech companies.

As depicted in the provided chart below, comparing the performance of S&P 500 large-cap stocks with Russell 2000 small-cap stocks, it's clear that small-cap stocks usually lead the way in economic recoveries, often reaching new peaks before the S&P 500. However, the post-COVID era marked a significant departure from this norm. challenges in the post-pandemic landscape, where traditional market recovery patterns, as previously seen, are no longer predictable.

S&P 500 and Russell 2000 small caps correlation since 1990

Besides small caps, mid caps – one of the fastest-growing segments of the stock market over the last 40 years – have been exhibiting a similar pattern. The S&P 400 Growth Index, a benchmark for mid-caps, has historically led the market's uptrends in secular bull markets. This dynamic is evident in the chart below until the onset of COVID-19. However, as of January 2024, the S&P 400 has yet to surpass its critical highs, failing to confirm the strong momentum seen in the S&P 500.

We can closely observe both charts and notice the red circles, which reflect the timing of the small-cap and mid-cap trend breakouts compared to the S&P 500. Over the last 30 years, both small and mid-cap stocks have consistently broken out ahead of the S&P 500. This is crucial to understand and visualize because it presents a comprehensive view of current market dynamics.

S&P 500 and S&P 400 mid-caps correlation since 1995

It's important to note that in a robust economy characterized by sustainable growth, small and mid-cap stocks are typically the forerunners in terms of growth, not large-cap stocks. This conventional wisdom underlines the concerning nature of the significant divergence we observe between the S&P 500 and Russell 2000 as of January 2024.

This marked deviation is a strong indicator that the market is currently not in a healthy state. It suggests that this unhealthy market dynamic may be pricing in unforeseen factors or events, diverging from established economic trends and expectations as of January 2024.

Yield Curve Dynamics and Recent Market Highs

Probability of US Recession Predicted by Treasury Spread during the last 12 months

Another intriguing aspect is the recent behavior of the Treasury yield curve. After a period of decline in the first half of 2023, the yield curve started to steep again in the last quarter. You can see this from the chart above. The steepening, traditionally seen as a sign of inflation risk or economic uncertainty, seems at odds with the bullish current S&P 500 trend.

- Yield Curve and Economic Risks: The steepening of the curve could be signaling that the market is starting to worry about a different set of risks, possibly related to something that is not public news yet.

- Misalignment with Bullish Market Trends: The deepening of the yield curve in recent months is not in alignment with the bullish trends of the S&P 500 and Nasdaq 100, especially considering the lack of support from small and mid-cap stocks. This discrepancy warrants a closer examination to understand the potential implications for future market movements and also an important dynamic in our 2024 stock market forecast.

The Trend of Long-term Bonds versus S&P 500

Triggered by COVID-19-induced inflation, the Federal Reserve has been compelled to raise interest rates to over 5% within a relatively short timeframe. This rapid adjustment has naturally led to a decrease in bond prices as yields surged. Significantly, this movement by the Fed has interrupted the long-term trend in long-term bonds.

This dynamic is clearly illustrated in the chart below, where we can also compare the bond market trend with the S&P 500's recent secular trend. This is another significant point because, in this context, bonds could serve as an indicator of the overall economy.

Examining the long-term trends of bonds and S&P 500

Conversely, such an increase in rates would typically disrupt the long-term trend of the stock market as well. A glimpse of this disruption was observed in October 2022, when bond ETFs deviated from their long-term trend, coinciding with the S&P 500 dipping to around the 3500 level. However, the S&P 500 demonstrated resilience, recovering from this long-term support point, influenced partly by the subsiding of inflation and a decline in energy prices.

Despite the recent recovery, the yield curve's ongoing steepening remains a cause for concern, often signaling increasing market trepidation. Concurrently, the persistent negative trend in long-term bonds serves as a potential harbinger for the stock market, suggesting an impending adjustment of the economy to the realities of the prevailing risks in global markets.

The relationship between the two key factors – Federal Reserve tightening and low medium- and long-term interest rates – in the context of a steeply inverted yield curve is critical in understanding why it often indicates an impending recession.

Federal Reserve Tightening short term rates and Its Impact:

When the Federal Reserve increases short-term interest rates, it's usually in response to concerns about inflation or an overheating economy. Higher short-term rates make borrowing more expensive, which can cool down investment and consumer spending. This slowing of economic activity is an intentional outcome of the Fed's policy to prevent the economy from overheating. However, an overly aggressive tightening can tip the economy into a slowdown, contributing to the onset of a recession.

Low Medium- and Long-Term Interest Rates as a Signal:

The lower rates on medium- and long-term investments typically reflect the market's expectations for future economic growth. When these rates are low, it suggests that investors anticipate weaker economic growth or possibly deflation in the future. This lack of confidence in sustained economic growth can become a self-fulfilling prophecy, as it leads to reduced investment in long-term projects and dampens overall economic momentum.

The Interplay in Yield Curve Inversion:

When these two phenomena occur simultaneously – the Fed raises short-term rates, and the long-term rates drop due to low growth expectations – the yield curve inverts. This inversion reflects a critical juncture: the immediate measures to cool the economy (higher short-term rates) clash with the market's longer-term economic outlook (lower long-term rates). Historically, this scenario has often preceded recessions, as it suggests both a current policy-driven economic slowdown and a lack of confidence in future economic growth.

To learn more about the yield curve please CLICK ON THE ARTICLE HEADLINE BELOW

An examination of the yield curve's performance since 1960 shows it has been about 90% accurate in forecasting recessions. However, the precise timing of these economic downturns can be unpredictable. The peak of the yield curve often marks the onset of a recession, but determining the extent of its steepening in current market conditions remains challenging.

Probability of US Recession Predicted by Treasury Spread since 1960

SOURCE: NEWYORKFED.ORG

Sometimes, recessions follow swiftly after an inversion, while in other instances, there's a notable delay.

In our present situation, we haven't seen an immediate materialization of a recession, as the yield curve is still in the process of steepening. The peak of the yield curve is a critical indicator; until it reaches this point, the signs of a recession might not be fully apparent. Once it peaks, we are likely to witness the initial indications of a significant recession unfolding from the declining stock prices.

Nevertheless, to accurately interpret the yield curve as a signal, it is crucial to consider the market's long-term relative strength, or, in other words, its secular trend force.

To do so, one key technique in our long-term market analysis is the examination of the market's relative strength over extended periods. Specifically, we analyze the 200-quarter Relative Strength Index (RSI) dynamics of the S&P 500 index. This analysis, encompassing approximately 50 years, allows us to identify potential shifts in market dynamics over various decades or years. By employing this method, we can readily pinpoint significant divergences within the broader market context. As shown in the accompanying chart below, the S&P 500 appears to be nearing the end of its latest bull cycle.

To understand this unique analysis, please examine the trend of the S&P 500 alongside the 200-quarter RSI. You will notice that every time the RSI breaks its trend, either way, the market tends to follow suit. In the past several quarters, despite a market rally, the long-term trend of the RSI is on the verge of breaking down from its 14-year uptrend on a quarterly basis. This observation is derived from our comparative study which, despite its simplicity, offers logical and insightful conclusions about long-term market trends.

S&P 500 ( 200 - Quarter ) RSI study since 1991

Upon closer examination of the S&P 500's performance over the past six quarters, particularly since October 2022, a notable discrepancy becomes apparent. The Relative Strength Index (RSI) has not reflected the market's overall movements during this period. Despite the S&P 500 achieving new highs, the RSI's lack of corresponding strength raises questions, echoing concerns similar to those indicated by the yield curve.

Meanwhile, another critical yet often overlooked market dynamic is the Equal-Weighted S&P 500 Index. This variant of the S&P 500 does not disproportionately emphasize the top 10 stocks, which conventionally constitute about 40% of the index. Instead, it offers a more balanced representation of the top 500 large U.S. companies, providing a clearer picture of the overall market strength. This perspective is vital because it better represents the true performance of these large companies, which collectively employ a significant portion of the U.S. workforce. Therefore, their performance offers a more realistic gauge of the U.S. economy's health.

S&P 500 Equal-Weighted Index Since 2006

The attached chart above reveals that the S&P 500 Equal Weighted Index remains significantly below its 2022 peaks ( about %10 ) , displaying a trend similar to that observed in mid-cap and small-cap stocks. Notably, when excluding the top ten stocks, the performance of the remaining large-cap stocks in the S&P 500 is even weaker than that of small-cap stocks.

This observation aligns with the implications of the yield curve, suggesting that the U.S. corporate economy might be teetering on the edge of a significant slowdown. Although a full business cycle downturn has not yet been triggered, our analysis highlights increasingly clear signs of this impending shift.

In this section of our report, we aim to present evidence that, despite surface-level appearances, the market is underperforming. In the following section, we will direct your attention to potential risks that could precipitate an economic downturn, marking the end of a 16-year secular bull market run. Our analysis delves into the factors that might catalyze this shift, providing insights essential for understanding the current market trajectory of 2024.

The recent conflict in the Middle East has undeniably heightened market risks, a trend distinctly observable in the yield curve's behavior since the onset of hostilities in early October.

The war's escalation from Ukraine to the Middle East is particularly concerning due to the strategic significance of the region. Despite the conflict's limited geographic scope, its regional impact is profound, far exceeding that of the Ukraine conflict in terms of potential global repercussions. This is largely because the Middle East is a pivotal hub for a substantial portion of the world's energy resources and crucial trade routes.

Examination of the ongoing conflict in the Middle East and its impact on global trade and economic dynamics.

One of the most direct effects is seen in the maritime domain, particularly in the Red Sea, a vital route for international shipping. Iran-backed Houthi rebels in Yemen have targeted over 20 ships, prompting major shipping companies like Maersk and Hapag-Lloyd to reroute vessels around South Africa's Cape of Good Hope instead of risking passage through the Red Sea and the Suez Canal. This rerouting is costly, adding up to $1 million in extra fuel for each round trip between Asia and Northern Europe, substantially increasing freight rates

Moreover, the escalation of the conflict poses a risk of broader economic repercussions. The Middle East conflict, along with the ongoing Russian-Ukrainian war, could potentially push global commodity markets into a state of uncertainty. The World Bank's Commodity Markets Outlook suggests that the conflict's escalation could trigger a 'dual shock' in global commodity markets, especially in the oil sector. This would intensify food insecurity, particularly in developing countries, and could lead to heightened food price inflation.

While the conflict's effects on commodity markets have been limited so far, any escalation could significantly disrupt global oil supplies. The World Bank outlines several risk scenarios, with varying degrees of disruption to oil supplies and consequent impacts on oil prices. A major oil price shock, if it materializes, would mark the first dual-energy shock in decades, resulting from both the wars in Ukraine and the Middle East.

It is a very high probability, that the market balance is likely to adjust to these escalating risks as new developments unfold in 2024, potentially leading to a sell-off. Such a shift could significantly dampen consumer and corporate sentiment, resulting in an economic shock.

Analysis of how the election results could affect global relationships and market sentiment.

This upcoming election is anticipated to be one of the most closely watched in history, as it is reminiscent of the chaos experienced during the 2000 election. We recall that 2000 was a year marked by significant market turbulence; the stock market began the year at all-time highs but then experienced one of its largest drops in two months, coinciding with the COVID-19 pandemic. This year could also be marked by heightened stress among consumers due to the clash of two distinct philosophical viewpoints vying for dominance in US politics.

In conclusion, the 2024 US presidential election is poised to have an unprecedented impact on global relationships and market sentiment. Investors and policymakers will need to closely monitor the election and its aftermath to navigate the potential changes in the geopolitical, and overall global sentiment.

Our market valuation analysis focuses on the top-performing stocks that have driven last year's rally in the S&P 500, from its lows of 3500 in October 2022. These stocks are not only the most liquid assets, preferred by large funds for their ease of trading, but they also collectively represent half of the Nasdaq 100 index. This makes them a critical parameter for gauging investor sentiment, as their liquidity and significant market share play a pivotal role in influencing overall market trends.

The analysis of current market valuations, particularly in the context of the large-cap market leaders.

We delve into basic valuation metrics for the top stocks on the Nasdaq, which include Microsoft (MSFT), Apple (AAPL), Amazon (AMZN), Nvidia (NVDA), Broadcom (AVGO), Meta Platforms (META), Alphabet (GOOG), Tesla (TSLA), Costco (COST), and Advanced Micro Devices (AMD). These ten stocks are market leaders, and we examine their future earnings expectations based on the average predictions of Wall Street analysts for 2025.

Our analysis primarily concentrates on the most optimistic scenarios, focusing on the highest earnings expectations estimated by analysts. We compare the average best-case earnings yield for these ten companies projected for 2025. Following this, we critically assess the optimistic earnings yield for 2025, placing it in context to ascertain the logic of owning these stocks at their current prices. This comparison involves analyzing their yield in relation to current Treasury yields, offering a straightforward method to determine whether these stocks, in the most optimistic scenario, present value compared to safer asset classes.

Top 10 Nasdaq 100 companies best possible Future PE ratios for 2025 earnings.

The analysis reveals that the average forward Price-to-Earnings (P/E) ratio for the top 10 stocks in the Nasdaq 100 is approximately 27. Amazon (AMZN) exhibits the highest ratio, while Meta Platforms (META) and Alphabet (GOOGL) display the lowest future P/E ratios, based on their high-end analyst earnings expectations for 2025. A detailed view of the best-case expected P/E ratios for 2025 for all top 10 Nasdaq companies is presented above. Additionally, the yield chart provided below offers insight into whether it is logical to consider these assets at their current valuations.

Top 10 Nasdaq stocks' current best possible earning yield expectations for 2025 and Yields.

SUMMARY:

The average forward P/E ratio of 27 for the top 10 stocks in the Nasdaq 100, under the assumption of optimal market conditions, corresponds to an earnings yield of 3.7%. In contrast, the Treasury market currently offers yields exceeding 4%. This disparity indicates that the leading stocks of the Nasdaq 100 yield less than traditionally lower-risk assets such as Treasuries even with their MOST OPTIMISTIC earning expectations for next year.

Discussion on whether the market is overvalued, fairly valued, or undervalued and the implications for investors.

To address the question, we must first consider the expected average growth for the next three years. If the market maintains a balanced trajectory and continues its average growth, with yields reducing to 3% from 5%, there might be a modest upside for the market. However, if we encounter a recession and global slowdown as suggested by the yield curve, a significant slowdown in earnings is likely. In such a scenario, stocks, particularly large caps that have been driving the recent market rally, may struggle to sustain their current valuations.From this perspective, stocks appear expensive, especially considering that even their best-case earnings for next year do not seem to offer yields superior to those of safer investment havens.

Bottomline given the risk factors, such as the yield curve indicating a 62% probability of recession, it's challenging to view these stocks as reasonably priced.

As we wrap up our comprehensive analysis in our stock market outlook report for 2024, several key points emerge, shaping our understanding of the current and future market dynamics.

As we look towards 2024, the bond market presents an intriguing landscape for investors. Two primary economic scenarios could unfold – a downturn or a 'soft landing' – both of which have significant implications for bonds, particularly when compared to stocks.

Scenario 1: Economic Downturn and Fed's Response

In the event of an economic downturn, it's likely that the Federal Reserve would respond by lowering interest rates from their current level of around 5% to a minimum of 3%. This action would be in an effort to stimulate economic activity by making borrowing cheaper and encouraging spending and investment.

Implications for Bonds:

When interest rates decrease, bond prices typically increase. This is because the fixed interest payments of existing bonds become more attractive compared to the new bonds issued at lower rates. As a result, in a downturn scenario, bonds, especially those with longer durations, could see significant price appreciation, making them a potentially attractive investment.

Scenario 2: Soft Landing and Gradual Rate Adjustments

Alternatively, if the economy manages a 'soft landing,' where it stabilizes or slows down without entering a recession, the Federal Reserve might still opt to lower interest rates, albeit more gradually. This scenario anticipates a steady decrease in inflation, allowing the Fed to reduce rates without igniting further inflationary pressures.

Implications for Bonds:

Even in this more balanced economic scenario, bonds could still be an attractive option. The gradual lowering of interest rates would still benefit existing bondholders, as bond prices would likely increase, albeit at a slower pace compared to the downturn scenario.

TLT: A Strategic Investment Vehicle

In both scenarios, an effective way to invest in bonds is through Exchange-Traded Funds (ETFs) like the TLT. The TLT primarily holds U.S. Treasury bonds with longer maturities. These bonds are particularly sensitive to interest rate changes, meaning they can benefit significantly from rate cuts.

Advantages of TLT ETF:

Risk-Reward Dynamics: Bonds vs. Stocks

In terms of risk-reward dynamics, bonds, particularly those represented in the TLT ETF, may offer a more attractive profile than stocks in 2024. This is especially relevant considering potential volatility and uncertainty in the stock market. Bonds offer a fixed return and are generally less volatile than stocks, making them a safer investment in times of economic uncertainty.

Conclusion

In both potential economic scenarios for 2024 – a downturn or a soft landing – bonds emerge as a compelling investment option. Whether through individual bonds or vehicles like the TLT ETF, they provide a combination of safety, potential for price appreciation, and a hedge against stock market volatility. Investors looking for a more conservative approach to navigating the uncertain economic waters of 2024 might find bonds to be a prudent choice in their portfolio.

2024 Strategic Portfolio : Balancing Stability, Income, and Capital Gains

In the midst of a challenging economic landscape, our 2024 model portfolio is carefully crafted to emphasize stability and high income, a strategy that is particularly pertinent in light of potential substantial stock market declines. The significance of this approach is underscored by the current high and persistently rising yield curve, widely regarded as an indicator signaling economic caution.

The backdrop of ongoing global conflicts and wars further contributes to a climate of uncertainty, intensifying investor apprehension. In this context, adopting a conservative investment strategy is of paramount importance. Our portfolio composition is predominantly oriented towards bonds, with a substantial allocation in the TLT. This choice is strategic, as bonds, particularly those in the TLT, exhibit lower sensitivity to market volatility and provide a more stable income stream.

Complementing this bond-centric approach, we have included high dividend-paying value stocks in the portfolio. This segment not only offers potential for income generation but also represents a value-oriented investment approach, typically exhibiting less volatility than growth stocks. The allocation to cash within the portfolio serves as a liquidity reserve and a risk buffer, crucial for managing uncertainties in today's market environment.

What sets this portfolio apart is its dual focus: while it is designed to be a robust, risk-averse investment vehicle for 2024, aiming to deliver stability and dependable income, it also considers the potential for reasonable capital gains. This is particularly relevant given the expectation that bond prices may increase as the Federal Reserve potentially lowers yields. Thus, this simple but very strategic portfolio model not only aims to protect against downside risks but also to capitalize on opportunities for capital appreciation in a reasonable Risk/Reward, making it a potentially optimal investment structure in our current analysis for 2024.

Analyzing the long-term trend of the S&P 500, we see a robust growth channel with an average annual return above 8%. Currently, the S&P 500 is trading at the upper end of this growth channel. This high valuation explains why small and mid caps haven't been market leaders recently - the market has exceeded its typical long-term growth rate. Consequently, small caps aren't necessarily undervalued, and the S&P 500 appears overpriced historically. This overvaluation might be why mid caps are also not leading, possibly reflecting anticipated future risks, similar to signals from the yield curve.

Publication date: 01/27/2024

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