To look ahead, one must often look backwards first. To paraphrase author Morgan Housel, you can learn more about the future by reading history than by reading forecasts.
The year began with most investors expecting a mild recession at some point during the year. Many investors were content to earn ~4.5% in a money market fund and wait for risks to dissipate. A sharp rally in January caught many off guard. A regional banking crisis, including the failure of several significant banks, produced a swift 10% market decline in March and further increased investor nervousness. The Federal Reserve intervened, the crisis turned out to be contained to a handful of banks, and the market rebounded. Buoyed by consistently strong economic data, the market rallied about 20% into the end of July. But the downside of economic resilience was that it led investors to fear a “higher for longer” interest rate regime. Rates rose rapidly during the summer and fall, with the 10-year Treasury exceeding 5% for the first time since 2007. This spooked stock investors, and the market fell about 10% again during the fall. Markets have since rebounded strongly as the Federal Reserve has signaled that they are likely finished raising interest rates. If that sounds like a rollercoaster to you, we understand. But after all of that, the S&P 500 is up about 24.5% for the year as we write this, and bonds, as measured by the Barclay’s Aggregate Index, are up 5.68% for the year (data from Morningstar). Even though cash, CDs and short-term yields were higher than they have been for over a decade, investors still gave up considerable upside if they played it too safe with money intended for long term goals.
We write this recap to highlight several things. First, a short recap of 2023 highlights the difficulty of forecasting. No one, us included, could have foreseen how 2023 would unfold. Had we only followed our economic indicators and fundamental analysis we would have likely tilted portfolios too conservatively. By also looking at technical analysis we were confident to stay invested. Listening to all of the indicators helps us to follow our process which kept us invested and holdings tilted towards pockets of strength that delivered results. With that backdrop we urge you to be mindful when reading 2024 predictions. We think our indicators, combined with the lessons of history, can give us insight into probabilities in the market. Secondly, it rarely pays to do what feels comfortable. There will always be risks present, and one must bear them to earn returns higher than inflation over time. Volatility is the emotional price investors pay for higher returns in the long run.
We have written often about the narrow breadth in the market in 2023; in other words, a relatively small number of stocks, concentrated in the technology industry, carried the market higher for most of 2023. That has changed in recent weeks. Small cap stocks have outperformed large caps in the recent rally, and the small cap index (Russell 2000) has advanced above a level that has capped rallies for the past 18 months. We expect much broader participation in 2024. This is a significant change, and a strong positive signal for the market as a whole. Additionally, the S&P 500 sits at nearly the exact level it did on 12/31/2021. History shows us that after 2-year periods of flat returns, the market usually responds with strong performance.
Economic data to this point is still consistent with a “soft landing” i.e., no recession. Meanwhile, forward looking indicators still suggest a recession is likely. However, history shows us that it is rarely profitable for people to time their investments around potential recessions. We urge investors to not get distracted by economic forecasts. That said, the potential for economic weakness is not the only risk on the horizon. Political and geopolitical uncertainty are also near the top of the list. Furthermore, investors may be overly confident about rate cuts from the Federal Reserve; any hesitation from the Fed could cause stocks to weaken temporarily. And the biggest risks are always the ones you can’t see. At some point, it is likely that one of these risks will materialize and cause an approximately ~10% decline in 2024. Indeed, history tells us that the average intra-year decline since 1980 is 14.3% (data from JP Morgan).
In conclusion, our indicators suggest another strong year in the markets. Even if the index returns are not likely to exceed this year’s 24.5%, it is likely to be a more target-rich environment with lots of stocks participating. However, it is also likely there will be declines along the way. We urge investors to stay the course in the face of uncertainty. And, as always, we will use our objective indicators to help us tilt accounts towards areas of strength in the markets.
