S&P 500 (SP500) and its counterpart fund, the SPDR S&P 500 ETF Trust (NEW YORK:SPY) touched a new high of 2023 recently and we have now seen a 21% increase year-to-date [YTD]. This is significantly higher than the average annual return of 11.6%. seen during the last decade. With the year winding down, the big question now is whether the index can continue to rise in 2024.
US GDP and the S&P 500
With little growth momentum, the macroeconomic context is no longer encouraging, indicating that it would be an underwhelming year for the index. To determine how the macro economy affects the S&P 500 index, first, the correlation between the annual average value of the S&P 500 index and US GDP levels over two decades is considered.
The two series have a strong positive correlation, with a coefficient of 0.94. To say it in perspective, a value of 1 indicates a perfect positive correlation and vice versa. A value of 0.94 then approaches a perfect correlation. It follows that a good growth for the economy would also be reflected in the S&P 500.
A softer S&P 500 average has been seen
In addition, it is not likely to be the case for 2024. The US economy may have narrowly avoided a speculated recession this year, but a softening of growth is widely seen in 2024. IMF assesses below-trend growth of 1.5% next year.
To determine what exactly this increase means for the S&P 500, a regression was run with GDP as the explanatory variable. This indicates that the average value of the S&P 500 index next year would result about 0.75% lower than the first level this year so far of 4257.2.
This sounds counterintuitive given that even at a slower pace, GDP will continue to see growth, which should show up in the index as well. The index’s expected correction is explained by the above-average performance of the S&P 500 this year, as noted earlier. Or to look at it from the other side, the average value of the index in 2023 was about 3% higher than that shown by the regression model.
Even so, after a time when macroeconomics was a focal point for stock markets, the economy is now entering more predictable territory. This means we are unlikely to see as many market-moving macro data and policy events as we have seen recently.
Apparently, the Fed is only done raising interest rates. Inflation is quite close to its comfort levels and is unlikely to affect market sentiment much going forward. Further, the Fed’s rate cut cycle is not expected to begin until late 2024.
Consider the downside risks
However, there may be exceptions to this expectation, as the rate cut cycle may start earlier if GDP growth moderates more than expected. It is not out of the realm of possibility, given that the IMF projection is not the worst. JP Morgan (JPM), for example, expects US GDP growth to come in even slower at 0.7%. The bank is backed by think tank the Conference Board, which similarly expects growth to come in 2024 at 0.8%.
Interestingly, however, even if growth slows that much, the average value of the S&P 500 index for the year would not be much different from the first estimate. The model finds that would be about 2% lower than levels seen this year so far. As would be expected, some sectors, such as consumer discretionary, are likely to bear the brunt of a broad decline in the index.
The odds are already coming in on results for consumer discretionary companies, which have seen demand soften in the US market in recent months. This is evident across the spectrum from the sportswear and accessories company Adidas (OTCX: ADDYY) to the luxury jeweler and watchmaker Richemont (OTCPK: CFRUY). I wouldn’t rule out a weak year for other cyclical segments like financials and real estate.
Unlike 2023, there may not be as much support from big tech either. This is important to note as technology holdings are the largest in the SPY, with an almost 30% share (see chart below). Stocks like Apple (AAPL) and Microsoft (MSFT) may show some weakness next year, going by their relatively elevated forward market multiples, as I pointed out recently. Others like NVIDIA (NVDA) and Amazon (AMZN) may still save the day, going by their forward earnings estimates, but the key point is that the overall upside from the technology may still be limited.
It’s not all bad
However, it doesn’t necessarily have to be a washout year. While signs certainly point in the direction of a slowdown in the US economy, there are still indicators pointing to potentially healthy outcomes. So far in 2023, GDP hasn’t exactly slowed down. In fact, in the third quarter (Q3 2023), growth was at a notable 5.2%, up from an already healthy 2.1% in Q2 2023. The healthy growth flies in the face of a widely speculated recession for the economy by earlier this year.
Also, not all forecasters believe the story of slowing growth. Goldman Sachs (GS), for example, predicts an increase of 2.1%. in 2024, even noting the fact that “The US economy defied recession fears in 2023 and made significant progress toward a soft landing.” Morgan Stanley (MRS), also sees somewhat higher growth of 1.9%even if it is a discount from the estimate of 2.4% for 2023. If this indeed turns out to be the case, the S&P 500 average will continue to be largely in line with the first numbers this year.
The key point here is that no matter how we look at it, the correlation between US economic growth and the S&P 500 does not indicate any dramatic change in the index over the next year. Not if there is a slowdown, not if there is better than expected growth.
However, it indicates that on average, there could be a correction in the average value of the S&P 500 index in 2024 compared to this year. This is partly due to the expected softening of growth next year, but also because the index has significantly outperformed its 10-year average growth in 2023. Basically, a 2024 under the influence of the S&P 500 is the most likely scenario so far.
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