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Market Commentary: Carson Investment Research Looks at the Year Ahead

Carson Investment Research 2024 Market Outlook: Seeing Eye to Eye

  • We are targeting a total return of 11-13% for the S&P 500 Index in 2024 and 4-6% for the Bloomberg U.S. Aggregate Bond Index.
  • We believe the odds of a recession remain low, with continued income growth, a recovery in rate-sensitive cyclical areas of the economy, and untapped potential for productivity gains helping to support the expansion.
  • We also share a long-term view of markets, highlighting the persistence of the equity risk premium and the value of diversification.

What a strange year we had in 2023. Market participants, strategists, policymakers, and the economy rarely saw eye to eye. Most strategists missed the underlying strength in the economy, leading to undue pessimism in what turned out to be a strong year for stocks. Skepticism about the bond outlook and a flight to money market funds appeared justified until the last quarter, when bonds rallied sharply. And consumers mostly remained gloomy about what was actually a good economy despite the most aggressive Federal Reserve rate-hike cycle in decades.

Carson Investment Research took an unpopular contrarian stance in 2023, calling for the expansion to continue and stocks to post solid gains, based simply on what we were seeing in the data. Consensus has moved toward our view in 2024, but we still see quite a bit of gloom out there, with several strategists holding to their recession calls. We take a deep dive into our outlook for 2024 in Carson Investment Research’s Outlook ‘24: Seeing Eye to Eye.

DOWNLOAD OUR 2024 MARKET OUTLOOK

The Macroeconomic Backdrop

As we look to the year ahead, our proprietary Leading Economic Index (LEI) indicates even lower odds of a recession than 2023. Our LEI places less emphasis on manufacturing and business sentiment and more on consumer spending, which makes up roughly two-thirds of the economy, than some widely followed LEIs. With the Federal Reserve very likely to start cutting rates in the first half of the year, and a solid job market supporting incomes, there’s plenty in place to support continued growth.

We also see strong potential for pick-up in productivity growth as falling interest rates support business investment. Lower rates may also help sustain momentum in the creation of new businesses, which typically boost productivity. And let’s not forget technological advances. It usually takes a decade or more for new technologies to impact the broad economy, but the pipeline is strong. Artificial intelligence was already being actively deployed a decade ago even if generative AI is new. In addition, the investment in the U.S. high technology manufacturing base in the last year has been extraordinary.

Our Market Views

This economic environment should support solid earnings growth and improved margins, leading to a good year for markets. While 2023 was a strong year, solid performance has not historically been a harbinger of market downside. To the contrary, it has often indicated a good market in the following year, only limiting the likelihood of a blockbuster follow-up year. The four-year election market cycle, which has held largely true to form in 2022 and 2023, also signals a solid year, especially when we have a first-term president (independent of party).

What may look different for stocks in 2024 is if the market rally broadens. While much attention was given to the strength of U.S. mega-cap stocks in 2023, we saw increased market breadth and valuations likely continuing, potentially supporting small- and mid-cap stocks.

After a strong late-year run for fixed income, some of the expected returns for bonds may have been pulled forward. But we still expect a solid year ahead for bonds as inflation continues to fall, the Fed lowers short-term rates, and flows from money market funds and other short-term instruments support demand after the great flight from bonds in 2022 and 2023. Something close to the yield-to-maturity for the broad investment-grade Bloomberg U.S. Aggregate Bond Index would be perfectly satisfactory. Just as importantly, with higher starting yields and falling inflation, bonds are less vulnerable to losses and are once again more likely to add ballast to a portfolio during periods of volatility.

Our bottom line: We expect markets, many strategists, and policymakers to once again largely see eye to eye in 2024 on broad outcomes, although we continue to tilt more optimistic than most based on the underlying data. We continue to favor the U.S., although valuations should help international markets see reasonable gains as well. While emerging market valuations are depressed, policy uncertainty, especially in China, continues to weigh on prospects. In fixed income, our economic outlook supports some tilt toward credit-sensitive bonds, but we prefer reflecting our economic outlook by overweighting equities.

Remember, even good years exhibit some volatility, so it’s important to be prepared to weather the market’s normal ups and downs. A 5% pullback in stocks has historically occurred three or four times per year, while a 10% correction occurs at least once per year. A 20% bear market has historically occurred once every three years.

Whatever happens, Carson Investment Research will be there to help, continuing to emphasize facts, not feelings, in our blogs, podcasts, and commentaries as we navigate the markets in 2024.

The Carson Quilt Chart

Just like that, another year is in the books. No two years are the same, and every year something inevitably defies expectations. For most of 2023, that something was the stock market. Expectations for a recession and a continuation of the dreary returns of 2022 were widespread. Investors were positioned for more pain, which was just the recipe for stocks to recover. Even more surprising was the huge turnaround in the bond market. An unloved asset class for all of 2022 and most of 2023, the broad aggregate bond index was negative for the year as recently as the beginning of November, only to rally 8.5% in the last two months to finish with more than a 5% gain.

While reviewing performance of the past year can be informative for investors, zooming out and taking a longer-term view is even more important. The chart below is our version of the industry staple Quilt Chart of asset class returns. We use the asset classes that make up our internal benchmarks (adding commodities), which also function as a neutral starting point for portfolio construction. We also include our moderate risk level benchmark (60% equity/40% bond target).

A significant amount of information — as well as lessons — can be gleaned from reviewing asset class returns over time.

Stocks and Bonds

As a riskier asset class, stocks require a return above bonds to compensate. For the last 16 years, that requirement has held true. Bonds have only outperformed stocks broadly in three of those years. But in each case, investors really needed bonds. No shortage of ink has been spilled about how bad 2022 was for multi-asset investors, but the beauty of bonds is they are self-healing. Higher interest rates due to price declines led to better expected future returns and a nice recovery in 2023, especially after all the accrued income is realized.

Value and Growth

After being the worst performing asset class in 2022, growth stocks regained the crown as the top performing asset class last year, riding the wave of the Magnificent Seven mega-cap stocks. We’ve mentioned this mirror image of growth and value before, and it shows just how difficult it can be to time the style decision. Growth stock dominance over the past decade has many drivers but is often attributed to ultra-low interest rates, which is an environment that may have changed. Valuation differences between value and growth remain at extreme levels (in favor of value), and some traditional growth stocks have gravitated toward the value side of the ledger.

Domestic vs. International

Similar to value, international markets have had a tough several years. In fact, developed international stocks have only outperformed domestic large-caps in four of the 16 years referenced, and they have had higher volatility. Currency effects add an additional layer of complexity and volatility to investing internationally. However, overseas markets offer a significantly larger opportunity set, lower valuations, and the opportunity for the right active manager to uncover the next big growth story.

Balanced Portfolio

Trends of the past may continue or could suddenly reverse. The only true guard against these changes is proper diversification. A balanced portfolio, proxied above by our moderate benchmark, will almost never be the best performing asset class, but it surely won’t be the worst performing either. In fact, the balanced portfolio above was only in the top three on one occasion, and that was 2008. The volatility of the past three to four years is a great example. Commodities moved from the worst performing asset class in 2020 to one of the best in 2021 and 2022 and right back down to the worst performing last year. That kind of volatility on its own can be maddening, but it can also be additive when used and rebalanced correctly.

Looking at the big picture can better frame for investors the temptation to chase returns and give up on the worst asset classes, and it can highlight the need for active rebalancing.

As my colleague Barry Gilbert noted in a prior blog, at Carson Investment Research we take a layered approach to portfolio management. Start simply and bring in depth when we think it will be rewarded. Currently, there is room to create a more robust allocation, but beginning with a simple, solid foundation can also do a lot of work.

We believe that a simple, diversified starting point for portfolio construction, with strategic and tactical decision-making to favor asset classes with attractive characteristics — all while maintaining broad diversification — leads to the best long-term outcomes for investors. Here’s to 2024!