The stock market has had a nice run in 2023, led by many big tech stocks. As investors began to anticipate the end of rising interest rates, they began pushing stocks higher, especially a group called the Magnificent 7, especially in the fourth quarter of the year. Now that the Federal Reserve has announced it will cut interest rates in 2024, stock prices have skyrocketed.
With stocks already trading at high valuations and uncertainty surrounding the economy and Fed actions, investors are eager to know where interest rates will head in the new year. But with the market led by a select few large-cap names, it looks like the stocks could peak.
How should investors proceed in this environment? Bankrate’s Market Mavens survey for the fourth quarter of 2023 asked professionals how much next year’s performance depends on rate cuts and what they expect from the Fed. We also wondered if the Magnificent 7 can continue to lead the market or if it will need to see a broad rally before the market can move higher overall.
Forecasts and analysis:
This article is one in a series discussing the results of Bankrate’s Market Mavens survey for the fourth quarter of 2023:
- Poll: Here’s How Experts Think Fed Policy Will Affect Stocks in 2024
- Survey: Investment experts see interest rates on ten-year government bonds falling in the coming year
- Survey: Stocks will soar 5.5% higher in 2024, professionals say
What the pros see on the horizon for stocks and interest rates
Most analysts in the survey predict that stock market performance in 2024 will depend largely on the Fed cutting interest rates, while some believe this is the only key factor. Others believe that interest rate and earnings growth combine to support stock markets. While many analysts expect several rate cuts this new year, a few analysts said rate cuts would not even be necessary.
“The market’s progress will depend almost exclusively on the direction of interest rates,” said Sam Stovall, chief investment strategist at CFRA Research. He expects the Fed to cut interest rates twice by 0.25 percentage points each in the second half of 2024.
“The market has built in big expectations for Fed cuts in 2024, and disappointment on that front could trigger downside volatility,” said Sameer Samana, senior global market strategist at the Wells Fargo Investment Institute. “We see only two to three rate cuts next year, in the second half, and that should help with both an economic and market recovery after a recession in the first half.”
“Markets expect more than 100 basis points of cuts next year. If the Fed makes just half of these cuts, stocks could fall 10 percent, based on the sensitivities shown earlier this year,” said Dec Mullarkey, managing director of SLC Management. But he cautions that the reasoning for the Fed’s actions matters significantly. If the Fed is cautious, the market can remain orderly, but if that is because inflation remains unyielding or even rises, a downturn awaits.
Other analysts think the Fed won’t cut rates next year or that corporate profits will be the bigger factor.
“In the near term, I expect a pullback if the Fed doesn’t cut spending,” said Brad McMillan, chief investment officer of Commonwealth Financial Network. “But since that lack of cuts will be driven by stronger-than-expected economic and earnings growth, the longer-term impact will be small. Stocks can do well at or around current prices, and easing will not be necessary.”
“Interest rates will certainly be a factor. But corporate profits will drive this market one way or another,” said Chuck Carlson, CFA, CEO of Horizon Investment Services. “In other words, the biggest risk to the market is a recession.”
What the Magnificent 7 Stocks Say About the Market
The newly christened Magnificent 7 stocks – Alphabet, Apple, Amazon, Meta Platforms, Microsoft, Nvidia and Tesla – have taken the market lead in 2023. This is partly due to the fact that they are the expected beneficiaries of AI and other technological developments, as well as favorable trade transactions. a dynamic that caused investors to crowd around these stocks and drive them even higher.
These stocks have a huge weight in the S&P 500 index, pushing the index higher even though many stocks are performing poorly. This situation – what experts call “narrow width” – is often a sign that the market is about to peak. But this situation can provide opportunities for nimble investors.
“Concentrated markets and limited breadth are typical of late-cycle dynamics, where slowing economic growth means fewer and fewer companies are benefiting or doing well,” says Samana. “We don’t see a huge expansion in breadth ahead of our predicted recession. Instead, it is much more likely that broader progress lies on the other side of a recession, once inflation is overcome, the Fed cuts rates and an economic recovery is underway.”
“If seven stocks can account for the lion’s share of a 20 percent gain for the market-cap-weighted S&P 500 in 2023, then it’s fair to say that their weighting definitely represents a risk to the indexes if that weighting is negative. way shifts. because there is so much concentration in those names,” said Patrick J. O’Hare, chief market analyst at Briefing.com.
“Given the size of their gains in 2023 and the concentration risk embedded in the Magnificent 7, we would favor an equal-weighted approach to the market in 2024,” he says.
Unlike the traditional S&P 500, where a company’s market capitalization determines its weight in the portfolio, an equal-weighted index gives each company the same position size in the index. Even the least weighted stock in these types of indexes has the same effect as an Apple or Amazon.
Magnificent 7 shares will have to continue to excel to keep the market on track unless market leadership expands.
“A lot of the returns for the Magnificent 7 in 2023 came from higher earnings, but a lot of it was rising multiples,” said Sonu Varghese, Ph.D., global macro strategist at Carson Group. “2024 will be about whether these companies can actually deliver on these higher multiples.”
So the market is already pricing in some earnings growth as a result of these factors yet to come. If not, the index as a whole could plummet due to their large weighting.
However, investors looking for good value may still be able to find bargains.
“The market has somewhat ignored the rest of the S&P 500, but in recent weeks that has started to change as investors look for stocks at a discount,” Mullarkey says. “Some battered sectors, such as regional banks and REITs, are receiving some attention.”
“We can expect the Magnificent 7 to calm down a bit, but valuations for the remaining 490 or so members of the S&P 500 are much lower and offer the potential to offset the outperformance,” McMillan says.
Also in this situation, an equal-weighted S&P 500 fund could be attractive because it gives investors exposure to that wide range of potentially cheaper stocks.
“Mega-cap stocks always represent risk to market-cap-weighted indexes,” said Kim Forrest, Chief Investment Officer and Founder of Bokeh Capital Partners. “It’s the math of it all. It will allow barbell investors like me to outperform when the shine wears off the Magnificent 7.”
Using the barbell strategy, as Forrest suggests, investors would look for opportunities in neglected stocks at the other, smaller end of the S&P 500. Another option is to look at small- and mid-cap stocks, which often are outside the holdings of the S&P 500. largest indexes and investors.
Methodology
Bankrate’s Q4 2023 survey of stock market professionals was conducted Dec. 1-11 via an online survey. Survey requests were sent by email to potential respondents across the country, and responses were submitted voluntarily through a website. The responses included: Kenneth Chavis IV, CFP, senior wealth advisor, Versant Capital Management; Sameer Samana, senior global market strategist, Wells Fargo Investment Institute; Patrick J. O’Hare, chief market analyst, Briefing.com; Dec Mullarkey, Managing Director, SLC Management; Kenneth Tower, CEO, Chief Investment Strategist, Quantitative Analysis Service; Clark A. Kendall, CFA, president, Kendall Capital; Sonu Varghese, Ph.D., global macro strategist, Carson Group; Michael K. Farr, president and CEO, Farr, Miller & Washington; Brad McMillan, head of investments, Commonwealth Financial Network; Sam Stovall, chief investment strategist, CFRA Research; Kim Forrest, chief investment officer/founder, Bokeh Capital Partners; Chuck Carlson, CFA, CEO, Horizon Investment Services.
Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making any investment decision. In addition, investors are advised that the past performance of investment products does not guarantee future price increases.
