Outlook continues to improve

Regular readers of this space know, when it comes to market calls, I prefer being lonely. Although more Wall Street types are being pulled gradually into the present market rally, I’ve been consoled of late that many are caving in only reluctantly and others have flat out told me, “You’re too optimistic.” I’ll confess to often looking for the silver lining in dark clouds, as I wrote about in the dog days of last August with the market 14% below where we are today (see Every Cloud Has a Silver Lining). But here’s the rub: time is usually on the side of the optimists. Owners of stocks are in effect owners of the global economy, and over time, the global economy grows in nominal terms. It always has, driven by productivity gains, trade, population growth and the compounding growth of the capital base. No surprise that stocks were up 17 years of the last 20. So in this context, our outlook for 5,200 this year and 6,000 by late 2025/early 2026 (i.e., single digit returns) is, well, cautious.

The basic building blocks of our view have been pretty simple. To boil it down, we have nominal earnings (the basic food stocks eat) growing about 9% annually through 2026, getting them back in line with the 43% nominal expansion of the U.S. GDP since 2019. We have inflation and interest rates declining, though we expect both to be stickier than normal. And we have perceived risk levels—ranging from commercial real estate worries, geopolitics and, yes, the U.S. election cycle—all likely to decline, not rise. Add all this up, and stocks can keep marching higher. Perhaps at a more pedestrian single-digit pace than recent years’ double-digit increases (and that one double-digit decline in 2022!) but up nonetheless. And finally, within this more stable equity environment, we’re expecting the market to broaden from the very narrow market we experienced last year, with value sectors such as financials, industrials, energy, utilities, international stocks, small cap stocks, and even some of the laggards within tech, all doing better.

Since our last piece, we’ve had a lot of incoming data vis a vis the building blocks of our cautious optimism. Frankly, it has been largely supportive. Let’s review.

1. Economic data has remained strong and inflation lower though resilient. Over the past month, virtually all the data we and others track has been coming in solidly positive, belying the undying call for a recession from our bearish friends. Whether it be strong personal income and spending, steady consumer confidence, better-than-expected manufacturing and services ISMs, rising JOLTS versus low unemployment, and stronger-than-anticipated nonfarm payrolls, the data suggests an economy on a solid growth path. At the same time, consistent in some ways with the still strong economic growth, inflation data has been sticky, though still well down off their post-Covid peaks. Last week’s CPI prints were scary for some, though we’d point out that imputed rents have a disproportionate impact on that number. Also, next week’s PCE (the Federal Reserve's preferred inflation metric) is likely to come in the 2.5% to 3.0% range, i.e., closer to the Fed's target. Overall, consensus is moving ever closer to our view that the recession, or what we called the Rocky Landing, is behind, not ahead of us.
2. The fourth quarter earnings season came in largely ahead of expectations and in line with our view. Earnings season is now effectively completed, with Magnificent Seven powerhouse Nvidia somehow beating expectations despite how high those expectations had soared. And although the season had its share of misses, the overall picture was well ahead of consensus and closer to our optimistic outlook. While expectations coming into the quarter were for year-over-year growth of 1.6%, as of this morning, the actual growth will be more like 9%. And that makes our $250 forecast for 2024 a lot more likely. None of this is that exceptional, given the better-than-expected nominal GDP numbers we’ve been seeing. To repeat: stocks eat nominal GDP. With it expected to increase 43% from 2019 by the end of 2026, it’s no surprise earnings have resumed their growth path after the four straight quarters of declines during the Rocky Landing.
3. The Fed minutes suggest they expect to take their time with rate cuts. In my first market memo of the year (Jan. 4), when the fed futures market was forecasting six cuts in 2024, I felt compelled to underscore our conviction this wouldn’t happen: “The Fed has paused but no way six cuts are coming this year. No way. No how.” Well, it hasn’t taken long for the consensus to shift our way. Already, due to the economic and earnings news mentioned above, the futures market is now down to 3.2 cuts and dropping. Our view on this issue remains the same. Having remained in stimulus mode a good 12 to 18 months too long following Covid, the Fed has now adopted a defensive stance, seeking to avoid its mistake in the 70s. That Fed, faced with a similar supply constrained inflation impulse to today’s labor-constrained economy, cut rates prematurely not once, but at least three times, only to quickly reverse course and hike again. The result was a loss of inflation-fighting credibility, which could only be restored by imposing a dramatic set of rate hikes and a harsh recession. Given these risks, our view remains today’s Fed will be patient before initiating the cutting cycle, and this week’s Fed minutes reinforced this point. We think the Fed won’t start easing until at least June, so one to three cuts are the most they’ll make this year. This gentler path is a key reason we see markets more likely to move ahead slowly rather than rip higher to another double-digit year.
4. The market broadening out that we’ve been expecting is starting but has a long way to go. If there’s been one weak spot in our call, it’s that the broadening we’ve anticipated has not fully happened—yet. Especially with Nvidia’s upside surprise, yet again, this morning, the Magnificent Seven continue to lead the charge. However, we’d note that the pace of their leadership is slowing, and that could be good news for the rest of the pack. Indeed, while in the first three quarters of 2023 the Mag 7 were up an astonishing 55% compared with 3% for everything thing else, since the market’s low on Oct. 27, the Mag 7 are up 28.8%, “just” 7.8% better than the S&P 500 without them. Importantly, several of the “Value” names our stock pickers like and track, whether it be in tech or autos or banks, have had a positive quarter, sometimes on less-than-stellar earnings reports. This presages well for our call here, especially as we reach the back half of this year when the Mag 7 will be dealing with tough year-over-year comparisons while many Value names will enjoy the opposite. If our $250 earnings forecast for this year is going to be right, we will need contributions from names in the financials, industrials, utilities and energy sectors. We’ll see.
5. Geopolitics remains ugly, but could get better. A key area of legitimate concern for equity investors is the state of global, and of course U.S. , politics. Everywhere you look, you see something bad: Ukraine a bloody deadlock, with no end apparently in sight; Israel still in Gaza, preparing a final push in the south; China’s economy softening, with Chairman Xi dug in with his anti-Western campaign; and, domestically, a much-dreaded Trump-Biden rematch marching closer to a reality. At the risk of further enraging my bearish friends, I’d like to suggest that in terms of this backdrop, we could be close to maximum pessimism. Both Ukraine and Gaza could be nearing what would amount to a semi-permanent occupation, at least in parts of both countries; not ideal, but less bad than the full blown wars we’ve had until now. China’s policy direction has been negative but could be about to turn. For sure, the economy is now in deflation, consumer confidence has tanked, investment is down, and even Xi’s inner circle is grumbling publicly. However, at least in the past, conditions like this have often led to a positive turn, which in this case could be reduced tensions abroad and more stimulus domestically. On the U.S. election, let me say this: even as the odds of a much-feared (in some circles) Trump presidency rise, many good things for stocks are probably in store: less economy-constricting regulatory overhangs, an extension of the supply side tax reforms of the first Trump presidency, a tougher policy on NATO (which would likely broaden, not lessen, European funding), a tougher border policy which could bring much-needed immigration to the U.S. down to a more sustainable and controlled inflow, and a tougher policy on China that could be a further inducement for Xi to adjust his currently overly belligerent course towards the West. Note that if Trump does win, his path to doing so would have been by cooling down the angry rhetoric, being more measured and even reaching out to disgruntled voters in the inner cities, which recently he seems to be trying to do. Overly optimistic? Perhaps. We’ll see.

It's a long year ahead and we’ve already made a lot of progress towards our 5,200 goal for stocks. But that progress has come largely because the news flow in the form of earnings, the economy and the Fed has been good. There are likely still a few positive surprises out there, especially in the more neglected areas of the market that have only recently started to perk up. We’re staying long and strong.