Where Market Indicators Stand as We Start 2024

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The headline numbers suggest the stock market is coming off a very good year. The S&P 500 index realized a sizzling 26.3% return in 2023.

We can trace the S&P 500’s big gain back to last March when two unrelated things happened. First, Silicon Valley Bank collapsed and was seized by regulators. Second, OpenAI released GPT-4. Combined, they revved up interest in growth stocks—especially technology-related growth stocks. This led to the stellar returns of the so-called Magnificent Seven stocks: Alphabet Inc. (GOOGL), Amazon.com Inc. (AMZN), Apple Inc. (AAPL), Meta Platforms Inc. (META), Microsoft Corp. (MSFT), Nvidia Corp. (NVDA) and Tesla Inc. (TSLA).

What will this year’s big catalyst be? Many people have thoughts, but it could well be something most aren’t currently talking about. I can tell you that there are two trends going in our favor: 1) The S&P 500 has historically risen during the fourth year of a president’s first term; 2) years with big gains are typically followed by years with more gains. To be fair, the S&P 500 has risen during far more calendar years than it has fallen.

Still, it is useful to occasionally take a step back and look at various market indicators to get a sense of where we are at as 2024 starts.

The Average Stock Lagged the S&P 500 in 2023—If your portfolio didn’t keep pace with the S&P 500, don’t feel bad. The Financial Times observed late last month that 72% of S&P 500 stocks were on track to underperform the S&P 500 for the full year. This was the highest percentage since at least 2000.

As I have previously pointed out, concentration in the S&P 500—which is a market-capitalization-weighted index—is extremely high. J.P. Morgan Asset Management says the 10 largest stocks accounted for nearly one-third (32.1%) of the index’s total market cap at year-end.

There Is Comparative Value in Value—Staying with data from J.P. Morgan Asset Management’s Guide to the Markets, small-cap value stocks ended 2023 with a price-earnings (P/E) ratio that was slightly below (2.6%) its 20-year average. Large-cap growth stocks ended 2023 trading at a 40.3% premium to their 20-year average price-earnings ratio. We at AAII have been noting the unusually large discount that S&P SmallCap 600 index stocks have been trading at relative to large-cap stocks on a price-to-book-value (P/B) basis.

The rubber band representing the relative historical valuations is very stretched. Could it have broken? Possibly. I personally think it will eventually snap back with a vengeance. The challenge with waiting for reversion to the mean (meaning a return to historical relationships) to occur is that it is not unusual for reversion to the mean to take longer to occur than many investors have the patience to wait. Those who do not anticipate it or think it won’t happen also get burned. Possible catalysts for small-cap stocks to take the lead are a decline in interest rates and a so-called economic soft landing.

Bond Yields Remain Inverted—Six-month Treasury bills yielded 5.26% at the end of December. The yield on the 10-year Treasury bond was 3.88%. This 138-basis-point difference is wider than we saw at the end of 2022. Inverted yield curves have historically preceded recessions. Plus, the Federal Reserve has a lousy record of achieving soft landings following interest-rate-tightening cycles.

Still, I’ll repeat what I wrote at the start of 2023: “It’s worth noting that there have been predictions of a recession occurring for many months now.” So, if we do get end up getting a recession sooner than later, it will be the most forecasted recession in history.

Earnings Expectations for 2024 Have Been Somewhat Steady—The LSEG I/B/E/S consensus estimate calls for S&P 500 earnings to grow by 11.1% in 2024. This forecast compares to 12.5% projected growth at the start of April 2023. Though down somewhat, it is nowhere near the downward revisions we saw analysts make in 2022 to their 2023 earnings forecasts.

Join us on Monday, January 8, at 2:00 p.m. Central Time for a live presentation on AAII’s Model Shadow Stock Portfolio. John Bajkowski will review the portfolio’s performance and discuss small-cap trends and insights during an interactive Q&A session. You can register here.