Current Investment Outlook

The stock market rose to new highs in 2023, despite facing skepticism throughout the year. The concerns were valid, but the market didn't care. As it often does, stocks rose by climbing a "wall of worry." One could argue that it was rising in the face of pessimism or that it was simply oblivious. Entering 2024, prevailing views are still cautious. The average gain for this year projected by leading strategists is a paltry 1-2%. Stocks that did well last year will lag, they believe, and stocks that lagged will lead. At the same time, there are still many investors who were spooked by the Financial Crisis of 2008 and have remained in cash ever since. Those cautious investors have missed at least a huge return in the market. We encourage investors to stay invested - and to look for individual stocks with attractive prospects and reasonable valuations.

The stock market and our economy in 2023 were characterized by the dichotomy between wealthy Americans and middle-to-lower income earners - and between a narrow group of high technology-oriented stocks and the rest of the market. The economy continues to grow, but many Americans have been decimated by inflation - which is slowing, but with prices at still highly elevated levels. Economically today, more than ever, we find that we are two Americas with significantly different prospects. As for stock leadership, it is tempting to conclude that last year's trends will reverse in 2024, but we believe that stocks with exceptional dynamics of growth and profitability will continue to lead. If we look, for example, at the returns on equity of the so-called Magnificent Seven, we find that (other than Tesla - which we do not own in size) the returns range from a 30% level to well over 100%, with an average of more than 50%. These are exceptional returns and these stocks have good prospects of continued leadership unless profitability declines materially.

The outlook for inflation is improving, having declined from a peak of over 9%, though it is still tenuous. The latest prints are 3.4% and 1.0% for the CPI and the PPI. Prices are expected to rise 2.4% in 2024. The easy money policy of the Federal Reserve and the money-printing by Congress have slowed and supply/demand relationships are more in balance. The Fed is poised to cut rates, but energy remains a wild card with hostilities in Europe and the Middle East.

The conventional forecast that interest rates have peaked is probably correct. Rates follow inflation expectations, and wage and price inflation seem to be moderating. The Federal Reserve previewed that they will pause and likely cut rates at some point in 2024. Since delivering that message, the Fed has had second thoughts and wavered somewhat. Nevertheless, the fixed income market seems to agree that rates have peaked and should work their way lower this year. It is uncertain as to the timing and number of Fed cuts, and action is not likely before mid-year. The expectation is that the Fed Funds rate will end 2024 at 4.25% vs. 5.5% now. The ten-year Treasury yield is poised to drop below 4% and the 30-year mortgage rate has dropped back below 7%.

The U.S. deficit in 2023 was $1.84 trillion, up from $950 billion in the previous year. These numbers are staggering. Federal debt has grown to $34 trillion, which translates to $101,400 per family. World debt is now at $288 trillion and is essentially out of control. The unfunded liability of our transfer programs (Social Security, Medicare, and Medicaid) - which would show clearly on the balance sheet if the government were a private corporation - increases our debt to well over $100 trillion. That would raise the Federal debt per family to more than $300,000. It is impossible not to conclude that the government is simply unserious about spending within its means. This situation is unlikely to change until we find ourselves in a fiscal crisis or we have a strong leader who can withstand the criticism of not spending more than our income. Until then, we are likely to continue to carry irresponsibly large deficits and debt.

We still have an extreme dichotomy in our economy between the most wealthy and other consumers. High income Americans are generally able to deal with our current price levels and inflationary pressures, but others are not. Housing may be the best example of the wealth dichotomy. Housing sales hit the worst level in thirteen years and there is a limited supply for sale. But, the average home price is rising, due to the sales of high-end homes. The average family is spending $700-800 more each month on food, gas, and housing, and this is an unbearable burden. The consumer reservoir of stimulus spending is winding down. In 2024, there should be less fiscal stimulus and a slowing in consumer and services. There may be a recovery in capital spending and housing, but a further weakening in commercial real estate. We believe that real GDP grew 2.8% in 2023 and should eke out a 0.7% gain in 2024. The problem is that we don't know if we have already had a recession, are about to slip into recession, or will have a soft landing of just slower growth. With the dichotomy, it is difficult to know.

Beyond a spectacular collapse in the Chinese economy and its stock market (due to massive over-building), the international news is dominated by hostilities in Europe and the Middle East, and it is hard not to have the impression that things are beginning to spiral out of control. This is a disturbing change from a mere three years ago. Russia may be on the brink of a negotiated settlement in the Ukraine. They have signaled that the Baltic States may be next - they are members of NATO and we would be compelled to respond. Israel continues to fight for survival against the Iran proxies of Hamas, Hezbollah, and the Houthis. China is biding its time and may invade Taiwan in due course. As we observed last quarter, markets don't enjoy conflict, but they have a history of being able to rise in the face of very troubling news.

The bull market began in October, 2022, when we had little company in taking an optimistic view. With a forecast of slight real GDP gains in 2024, we think that we will avoid slipping into recession. The outlook for corporate earnings is healthy, with a forecast for the S&P 500 of 220 for 2023, 250 for 2024, and 275 for 2025. This would put the market price-earnings ratio at just under 20 times, a high level that relies on good earnings gains going forward. This level of valuation allows stocks with strength in earnings to be rewarded and may punish those that fall short. In other words, this remains a perfect time for careful stock selection.

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