Twelve months ago, Tom Lee bet that 2023 was going to turn out very well.
As many of his peers on Wall Street sounded the alarm about a looming economic recession, Lee, a stock market strategist who spent more than a decade running JP Morgan's equity research before starting his own firm, forecast in December 2022 that falling inflation and economic resilience would counteract the broadly bearish sentiment.
Mr. Lee was right. Despite brinkmanship on the nation's debt ceiling, a banking crisis in March, fears about the cost of financing the government's fiscal deficit, an ongoing war in Ukraine and a new conflict in Israel, the core of the Lee's prediction came true in 2023. Inflation has fallen, unemployment remains low and the S&P 500 is up 24 percent.
Most investors disagreed with Mr. Lee's forecast; In 2023, they withdrew more than $70 billion from funds that buy U.S. stocks, according to data from EPFR Global. According to Morningstar Direct, only a quarter of fund managers whose performance compares to the S&P 500 have outperformed the index this year.
“2023 was a year where people were so convinced we were going to have a recession and they looked at everything through that lens,” said Lee, head of research at Fundstrat. “Then there were people like us who said we don't know the future but there is little evidence that a recession is coming.”
Looking ahead to 2024, forecasters tracked by Bloomberg share Lee's optimism more broadly, including analysts at Citigroup and Goldman Sachs. Binky Chadha, a Deutsche Bank equity strategist who bet against the consensus with Lee last year, also predicts the bullish rally will continue.
At the same time, analysts at Morgan Stanley, JP Morgan and others argue that the absence of a serious recession in 2023 does not mean it has been completely avoided, as the full effect of higher interest rates is still weighing on the economy. economy.
“There are a lot of things that have to go right to come out unscathed,” said Mike Wilson, chief equity strategist at Morgan Stanley. He revised his bearish bets in July, although even then he did not change his stance that the economy would get worse.
Central to both views is the trajectory of inflation and whether the Federal Reserve can return the pace of price increases to its 2 percent target before the economy falters.
The Federal Reserve began slowing the economy in March 2022 by raising interest rates. But recently the central bank seems confident that it is getting closer to its goal. The Consumer Price Index rose 3.1 percent over the year to November, down from a peak of more than 9 percent through June 2022. Core CPI, which excludes volatile food and energy prices , remains at 4 percent.
The sooner the Fed reaches its goal, the sooner it can begin to take its foot off the brakes on the economy. The central bank recently forecast lower interest rates next year. Even without rate cuts, falling inflation and historically high wage growth could encourage consumers to keep spending, offering a tailwind for corporate profits to soar even higher, Lee said.
Others are less confident. While the labor market remains strong, recent months have shown early signs of weakness, with unemployment rising modestly as more people begin looking for work. Credit card delinquencies and the number of people behind on auto loan payments are also rising, as investors note that consumer finances have become more strained after the repeal of plans to forgive debt. student loan debt. With inflation still above the Federal Reserve's target, these cracks could widen over the next year.
Jason Hunter, equity strategist at JP Morgan, said the market appeared to be ignoring an expected slowdown in growth next year. “It seems like the stock market is expecting a very optimistic outcome,” he said.
While the service sector of the economy, such as restaurants, has held up well this year, manufacturing has struggled after a period of overproduction in 2022.
Energy stocks remain negative for the year, having been a standout performer in 2022. Utility stocks, typically a haven when other parts of the market are in turmoil, thanks to their steady stream of income, have fallen further 10 percent since January. Smaller companies have also languished, with the Russell 2000 index still about 20 percent below its previous high and up 16 percent on the year.
For Lee and the growing pack of market bulls, these underappreciated areas of the market offer an opportunity in 2024. A turn in the manufacturing crisis, as companies resolve inventory builds and begin placing new orders, could help companies that had difficulties. in 2023 catch up.
Deutsche Bank's Chadha noted that economists had systematically underestimated the amount of growth in the economy this year. He believes it is likely to happen again.
“We think we will have positive growth surprises that will drive stocks higher,” he said.
Those who are more pessimistic say that the manufacturing recovery is far from assured and that the decline in those sectors of the market in 2023 could be a warning that if not for a few giant technology stocks that lifted the S&P 500, the rebound of stocks would be very different.
These tech stocks have been so dominant that they even earned the nickname the Magnificent Seven. It is a group that has some of the largest companies on the market: Apple, Microsoft, Alphabet, Amazon, Nvidia, Meta and Tesla.
“If average companies don't see improvement, to me that's the risk of a hard landing,” said Morgan Stanley's Wilson. “If we're going to have a recession, it's going to be when these companies decide to start laying people off.”
For Lee, history suggests a different outcome. When the S&P 500 has risen at least 15 percent, which has happened 28 times since 1950, the index has risen another 10 percent the following year half the time, and is positive more than 70 percent of the time. said. And when interest rates have previously been between 3 and 5 percent, the stock market valuation has been similar to what it is now, suggesting the rally is not overblown.
“People are trying to be too theoretical about the stock market,” Lee said. “Accepting chaos is a more correct way to approach the market.”
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