Congratulations! The S&P jumped 1% today to set a new all-time high, topping the January record from two years ago. Hopefully, your portfolio is back to record levels as well.
Let’s take a moment to enjoy the milestone.
Now, we’re more than happy to keep racking up gains as this market climbs, but as we’ve stressed for months, we must stay aware of potential landmines. After all, as famous trader Paul Tudor Jones once said, “Don’t focus on making money, focus on protecting what you have.”
On that note, while we enjoy today’s new high and hope for more to come, let’s look at some logic holes in the rosy 2024 stock market forecast.
Let’s begin with U.S. consumers and how their spending may or may not support earnings growth in 2024. This is important because in the long-term, stocks mirror the strength (or weakness) or a company’s underlying earnings.
So, if we want healthy portfolio returns this year then we need strong earnings – which means we need a strong consumer.
For context, let’s start with the S&P’s earnings growth rate from last year.
We don’t have the full data yet because we remain early in Q4 earnings season, but as I write, Multpl.com shows that 2023 earnings growth through Q3 was -1.51%. And FactSet pegs Q4’s earnings growth rate at -0.1%.
Let’s make it easy and just sum this up as “2023 had negative earnings growth.”
Looking ahead to 2024, FactSet reports that analysts are expecting robust earnings growth of 11.8%.
Enter inconsistency number-one
So, how does this negative-to-positive earnings forecast sync with the following analysis from The Wall Street Journal:
The economic expansion, however, is forecast to slow to a 1% rate in 2024, according to the WSJ survey, because the labor market is expected to moderate and consumers and businesses will feel the lingering effects of higher interest rates.
Or this analysis from Fitch Ratings:
Fitch Ratings estimates the total debt service to income ratio of U.S. households will increase to 11.7% by 2025 from 9.9% in 2022…
…The sharp increase in credit card rates and the resumption of student loan payments will drive non-mortgage household debt service to historic highs in 2024,” said Olu Sonola, head of U.S. regional economics at Fitch. “This will likely contribute to a slowdown in consumer spending in 2024.”
Or this analysis from CNBC:
Consumer spending remained remarkably resilient throughout 2023, even in the face of prolonged inflation and high interest rates. But that’s unlikely to continue, according to Jack Kleinhenz, chief economist at the National Retail Federation…
Recent reports already show signs of strain…
…More cardholders are carrying debt from month to month and fewer are able to pay off their balances in full.
“We are still largely a paycheck-to-paycheck nation,” said Mark Hamrick, senior economic analyst at Bankrate…
“The labor market looks set to cool further this year, which will impact consumer expectations for employment and wage growth, and, in turn, affect spending decisions,” Kleinhenz said.
“Spending is elevated relative to current income, and maintaining the recent pace of growth will be increasingly difficult.”
The bottom line is that whatever the shape of the U.S. consumer in 2023, it resulted in negative earnings growth for the S&P.
And yet, despite estimates across the board for a weaker U.S. consumer in 2024, the forecast for the S&P’s earnings growth is leaping from “negative” to “double digits.”
That is logically inconsistent.
Meanwhile, what do we learn if we shift our focus to corporate America directly?
Earlier this week, S&P Global Ratings reported that the number of companies failing to make required payments on their debt jumped 80% in 2023.
Don’t expect that to ease in 2024.
From CNBC:
Corporate debt defaults soared last year and could be a problem again in 2024 as cash-strapped companies deal with the burden of high interest rates, S&P Global Ratings reported Tuesday.
S&P said there could be hard times ahead for corporate America, which, according to the Federal Reserve, is carrying a $13.7 trillion debt load.
Company debt has jumped 18.3% since 2020 as companies took advantage of the Fed slashing interest rates in the early days of the Covid-19 pandemic.
“In 2024, we expect further credit deterioration globally, predominantly at the lower end of the rating scale (rated ‘B-’ or below), where close to 40% of issuers are at risk of downgrades,” the firm wrote. “We expect financing costs to remain elevated despite the prospect of rate cuts. And while borrowers have reduced their 2024 maturities, a large share of speculative-grade debt is expected to mature in 2025 and 2026.”
Some economists worry that a “corporate debt cliff” could become a more serious problem as a large share of maturing debt that initially was financed at very low rates comes due in the next few years.
The recruitment firm Challenger, Gray & Christmas reports that companies are buckling down right now. This bleeds through to employees and their spending ability.
From the Challenger, Gray & Christmas’s 2023 year-end survey in mid-December:
“Companies are approaching the end of the year with extreme caution. Attracting and retaining talent is not as high a priority as it was in 2021 and 2022,” said Challenger…
The year-end bonus is a tradition for many employers, but 2023 is seeing the highest rate of companies not hand out bonuses since 36% of companies opted not to give out bonuses in 2019…
“As companies enter 2024, they are doing away with the small tokens of appreciation in favor of saving money during a time perceived economic softness,” said Challenger.
“Companies’ year-end plans are reflecting the position that 2024 will bring slower growth. With companies slower to hire and workers more likely to stay in their jobs, companies are cutting where they can…” said Challenger.
As before, consider the inconsistency…
Despite these increased 2024 corporate headwinds relative to 2023, the S&P’s earnings growth rate is supposed to go from negative to double digit growth.
And what about the inconsistency in interest rate cuts?
As we’ve detailed in the Digest, even though the latest Fed Dot Plot suggests only three quarter-point cuts next year, Wall Street is currently pricing in six or seven. A handful of Federal Reserve presidents have spoken publicly in recent days, trying to talk down such rate-cut expectations, but the market doesn’t seem to believe them.
Now, taking a step back, why does the Federal Reserve cut rates in the first place?
Well, this happens when our economy needs stimulative help. Lower interest rates encourage businesses to invest in growth initiatives. They also make it easier for consumers to borrow and spend money.
Basically, rate cuts are salve for an ailing economy.
So, here’s the question…
With forecasts calling for 11.8% earnings growth in the S&P in 2024, where is the ailing economy?
Take a moment and really think this one through. Why would the Fed – still nervous about a flare-up in inflation – cut rates six or seven times in 2024, which would be very stimulative for the economy?
Sure, they might cut rates twice or perhaps three times to make sure that the current interest rate level doesn’t become too restrictive as inflation continues falling, but six or seven times?
In what scenario is that necessary absent a recession?
Remember, the near-zero Fed Funds rate days of the 2010s were an anomaly. According to YCharts, the long-term average Fed Funds rate is 4.60%.
Why are some traders expecting a return to 3%ish?
Back to earnings, it feels to me that “slow earnings growth” gets all the press when we talk about subdued inflation expectations in 2024, but “strong earnings growth” takes the spotlight when it comes to 2024 market predictions.
Can we really have it both ways?
To be clear, this is not a “get out of the market” warning
But it is a strong recommendation to be deliberate about investing in the corners of the market where earnings performance can meet – or exceed – expectations.
As we frequently say here in the Digest, the market is not one big monolith that rises and falls in unison. It’s comprised of thousands of different stocks with wildly different fates and fortunes.
The easiest way to see this is by comparing the S&P 500 Index with the Equal Weight S&P 500 Index.
In short, the Equal Weight Index gives every company within the S&P the same weighting in its overall performance calculation. This provides us a more realistic analysis of how the average stock is doing.
Meanwhile, the regular, weighted S&P Index is heavily influenced by the Magnificent Seven stocks that receive enormous index weightings and had a monster 2023.
As you can see below, while the S&P 500 soared 24% last year, the average S&P stock did half as well (up just 12%).
And what if we didn’t include the Magnificent Seven at all in our Equal Weighted return calculation?
Well, that average return would drop to about 7%. Not bad, but hardly the explosive year it appears to be on the surface.
Point is, forget “the market.” Instead, go where the strength is.
Jeff Remsburg
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