'Buy me now, or buy me later'
Secular bull market reconfirmed; long-term prospects rising.
As we slog through the fourth quarter 2023 earnings season, investors are slowly but surely being dragged by their heels into a rally that is, well, unloved.
“So many uncertainties ahead!” cry some. “But the Fed hasn’t even begun to cut!” others bemoan. “Earnings season so far has been mediocre at best!” another pipes in. “By the way [whisper, whisper], that recession I forecasted four times last year could still happen…trust me!” a doomsday economist warns. “Not to mention all the political uncertainty here and abroad,” mumbles another.
Still, the market shrugs all these worries off, and instead, much to everyone’s surprise, keeps churning on, in a slow, steady—and yes “Boring” upward trend (See 2024 Outlook: Less rocky, more boring).
While all of the above concerns are real, for sure, our base case remains that the market will find a way to grind through them all to a modest, high single-digit return this year and even next. Indeed, the list cited playfully above seems more characteristic of a more normal Wall of Worry than symptomatic of a pending dramatic decline. With the economy having emerged successfully from the asynchronous recession/“rocky landing” of 2022-23—inflation having peaked, the Fed having pivoted to rate cuts from rate hikes, and earnings, yes, having resumed their incline after a year-long profits recession—our outlook for stocks remains relatively sanguine. And importantly, the market broadening that began in the fourth quarter (and has had a bit of a correction since) offers stock pickers even better than single-digit returns ahead, in our view.
Corresponding to this positive fundamental backdrop, we’d add this “technical” point: the long-term secular bull market that began in 2013, and which we’ve highlighted in these pages for over a decade, earlier this year strongly and definitively re-asserted itself, breaking to new highs after a two-year correction that ended on Jan. 19. We don’t think this was an accident. And with the bull back in charge, reluctant investors are faced with this quandary: “Do I buy stocks now, or do I buy stocks later at what will most likely be higher prices?” Hmmm.
Let’s unpack all of this.
Earnings have bottomed
The bears, for sure, have been hammering away in the first stage of earnings season last week that year-over-year (y/y) earnings so far have been modestly negative. While that statement is true, what is also true about the companies that collectively have reported so far is that, despite the overall average result being -2% y/y, this was actually significantly better than expectations, and expectations for the full market this quarter remain for positive y/y growth. Most of the negative numbers have been in the banking space, which everyone knows has been under pressure and, it turns out, was not as negative as even analysts in that space expected. This week, we’ve had a barrage of companies with numbers all over the map, for sure, supporting our “this is a stock picker’s market” theme. Net net, with some of the big earners within the index in tech, communication services and consumer discretionary reporting next week, it seems we are on track to beat expectations for the fourth quarter of a 2% growth over 2023—marking the second quarter in a row of positive y/y earnings growth for the market after four quarters of decline. Said differently: earnings have bottomed.
And importantly, overall expectations of solid earnings growth for 2024 have been stable as analysts update their models, with the overall S&P 500 still expected to post $242 in earnings this year, a growth rate of 10%. (Our own estimates at Federated Hermes are a bit higher, at $250.)
In our view, 2025 and 2026 are likely to be substantially higher. By 2026, nominal GDP likely will have grown more than 40% from its 2019 level (with this week’s 2023 GDP print, it’s already up 27%). Assuming we’re right that, by then, with the post-Covid economic irregularities re-normalized, corporates will get their earnings back in line with their normal relationship to GDP, earnings should be in the $300+ range—roughly in line with what bottom-up analysts are projecting for 2026.
The Fed’s direction is clear…down
Market pundits can debate all day about which month, March or May, the Fed starts cutting and how far it will go this year versus next. While the timing of the first cut will affect daily trading, no doubt, the direction is now clear. Inflation peaked long ago and is headed lower, to 3% at least. This makes the Fed discount rate at 5.5% unsustainably high. So, rates are coming down. Our guess as to where they land is less aggressive than the market’s (we think a 3.5-4% level on the 10 year is where we’re heading). Yet, even that 10-year yield makes equities relatively attractive. Most of our work on equity valuations and bonds suggests that a 10-year yield in this range is generally supportive of an 18-20 multiple on forward stock earnings. So assuming nominal earnings continue their seemingly inevitable march toward $300 (by 2026?), sooner or later the market is likely to test the 6,000 level. Unlikely in 2024 and maybe even in 2025, but certainly feasible on a three-year view. This, again, implies high single-digit returns on market averages over that time frame. Not spectacular, maybe even boring, but still better than other asset classes ahead. And again, with the wide disparity at present between the Magnificent Seven and the rest of the market, stock pickers will have an edge at doing even better than that.
As always, uncertainties abound. High on the list are the coming Presidential election, widespread geopolitical uncertainty and the still looming threat the labor market finally cracks, bringing down the economy. Our view is that these uncertainties actually are uncommonly minimal relative to other, dicier periods. Although the election is likely to be close, both candidates probably offer some positives and some negatives for the market (a separate piece on this will be forthcoming). Importantly, both are in effect incumbents and less likely to surprise the market negatively. Geopolitical risks remain high, though less so than in the early days of the Russian invasion of Ukraine and the darkest days post the October 7 massacre. Both conflicts seem to be grinding toward a conclusion of sorts. And while the labor market is softening, and a theme of the earnings season so far has been “cost efficiencies,” given the still yawning gap between job openings and labor availability, the likelihood of a sustained period of net job losses seems low. Without that, GDP is likely to continue to surprise to the upside; witness this week’s release for the fourth quarter of 2023.
'The line moves up and to the right'
One of the most obvious, though frequently overlooked, realities of stock market history is that over time, the chart of equity market valuations moves ever higher. That’s not an accident. Stock investors own shares of some of the best companies in the world, participating in a growing global economy. As the economy grows, the earnings of those companies grow with it and so does the market level.
Presently, we are in the mid stages of one of the three great secular bull markets of the last 100 years. Each of these followed a long, protracted 10-to 20-year secular bear market, in which markets produced zero returns with lots of risks and volatility along the way. The current bull, which began in 2013 when the S&P finally broke through the old double high of 1999 and 2007, has been driven by a combination of strong nominal GDP growth, powered by a “third industrial revolution” (in tech and health care). Like all bulls, it’s had its share of steep 20-35% corrections (in 2018, 2020 and 2022), but never more than that and never for too long. This last correction, of 22% at its depth and a full 24 months in length, raised concerns for sure; it was getting a little long in the tooth, but not fatally so. So for us, the breakout earlier this month, which coincided with our positive fundamental-driven view that such a breakout would occur, was confirming. That doesn’t mean a 10% or so correction can’t happen; most likely it will when we least expect it. If it does, it would be a terrific chance to add more to stocks. But waiting for it could take a while, and the correction could well be from much higher levels.
We think the bull is back and it's time to get on board. Buy me now, or buy me later (and higher?)