“It’s hard to make predictions, especially about the future” – Yogi Berra
As we approach the end of 2023 and conclude that all things considered and despite higher interest rates, energy sector volatility, the war in Ukraine and The Middle East and the rapid emergence of AI, the year will end with an S&P gain of somewhere around 9% including dividends, a return more or less in line with the history of the Standard & Poor’s 500 Index. Looking to 2024, I project index – measured by its proxy SPDR S&P 500 ETF Trust (SPY) will end the year with the index at 4000 and the SPY trading at $400, a loss of over 10% for the year.
The US economy is on the brink of recession, despite popular calls for a “soft landing” from rising inflation that has seen interest rates rise from near zero to the 5% range for US Treasuries and the Fed’s policy rate to 5.25% to 5.5%. Inflation persists in part because of the massive federal debt and persistent trillion dollar deficits with the national debt now exceeding $34 trillion. Quantitative Easing (“QE”) fueled much of the growth of the past decade or two, but monetary policy has now shifted to Quantitative Tightening (“QT”) with the Fed now trying to reduce its trillion dollar balance sheet by about $90 billion a month (two-thirds Treasuries and one-third mortgage-backed securities) and actually compete with Treasuries for bond buyers.
The Treasury will need to raise about $6.3 trillion in 2024, including the refinancing of maturing debt and the projected federal deficit of about $1.5 trillion. Bond buyers have been hit by the Fed’s interest rate policies driven by the need to curb inflation and may be wary of exposing their portfolios to more bond risk and the risk of a “buyer strike” when a debt auction fails.
At the same time that risk in the credit markets is now higher than normal, the S&P is (in my opinion) overvalued at about 24.6 times earnings with a Shiller CAPE ratio of almost 25. The cyclically adjusted price-to-earnings ratio of Shiller has been a reliable harbinger of market declines since it was first introduced.
With 2024 a presidential election year, there is little chance of fiscal restraint. Incumbents running for re-election rarely have an interest in reining in spending at the risk of upsetting the electorate that benefits from government largesse. Given the Biden administration’s track record of budget overspending, I think the deficit will be closer to $2 trillion.
Ultimately, stock markets converge on fundamental value. SPY tracks the economy more or less and currently has a dividend yield of 1.56% or approximately $7.15 per unit for 2024 based on the current price of $451 and is increased by expected economic growth. (reports Bloomberg that economic growth for 2024 is likely to be around 2.1% according to a survey of economists.) SPY can be valued using the Gordon Dividend Growth Model which is appropriate for valuing a continuously growing, paying security dividend and SPY meets those criteria.
The Gordon model is shown below by Investopedia website:
Assuming a 2024 dividend in SPY of $7.15 and long-term economic growth of 4% at a cost of equity (or required rate of return, adjusted for inflation) in the S&P at historical average of about 6.9%the value of SPY is: Value = $7.15 / (0.069 – 0.04) = $246
Both the CAPE index and the Gordon model point to significant SPY overvaluation.
There’s an old Wall Street rule of thumb that suggests the appropriate price-to-earnings ratio for the market is 20 times the rate of inflation, which today would be in the 17 times range. SPY’s gains are around $20, which at a sum of seventeen will put a value on SPY of $340.
What seems clear is that the market today is anticipating higher growth and higher profitability or is satisfied with a much lower rate of return than historically. I don’t buy either. While AI and lower inflation are tailwinds, tight credit markets and geopolitical forces more than offset them in my view, and I see little chance of the market ending 2024 higher than 2023.
A few events can change everything. The resolution of the Arab-Israeli conflict and the end of the war in Ukraine are both reasonable expectations for 2024. Artificial intelligence could accelerate productivity and see profits grow at much higher rates than recent history. Efforts to curb inflation can bring inflation back to the 2% target or at least demonstrate progress towards this target. And, increased oil production from the United States has the potential to lower energy prices. The outcome of the presidential election will almost certainly be a factor, whether Biden, Trump or someone else is elected, but the effect is impossible to measure.
In broad terms, a macroeconomic approach to stock market forecasting for a broad index like the S&P is reasonable. I expect real GDP growth in the 2% range to be possible, inflation to remain above the Fed’s 2% target but fall slowly, and interest rates to remain at today’s levels or slightly higher. In that environment, the market as measured by the SPY should fall.
or paper by Austin Murphy and Zeina AlSalman found significantly lower capital returns when current interest rates and the previous year’s inflation rate were higher, shown in this table from their paper. Lower stock market returns result from contractionary monetary policy, among other factors. 2024 is likely to be another year of contractionary monetary policy.
Taking all factors into account, I predict that the S&P will end 2024 at 4,000, more than 10% below current levels.
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