The Big Banks bad 2023 predictions … a snapshot of today’s pricy stock market … where Luke believes we’ll see the most 2024 outperformance … can the S&P keep rising despite its valuation?
The Big Banks stunk it up last year with their market predictions.
Going into 2023, here were their estimates for the S&P’s performance:
- Barclays: -4%
- Morgan Stanley: +1%
- Citigroup: +1%
- Bank of America: +4%
- Goldman Sachs: +4%
- RBC: +7%
- JPMorgan: +9%
- Wells Fargo: +12%
And the S&P’s actual 2023 performance?
+24%.
To be fair, making market predictions is incredibly challenging. I’ll humbly admit that my own predictions wouldn’t necessarily have fared any better.
But that’s why I’m thrilled to throw humility out the window as I point toward Luke Lango, whose 2023 predictions were shockingly accurate.
Here’s a quick tour through the nine out of 10 predictions that Luke got right last year:
- Inflation fell much faster than collective opinion anticipated
- The Fed paused its rate-hiking campaign
- The economy averted a recession
- Stocks soared in the back half of the year
- The S&P 500 rose at least 20%
- The Nasdaq rose at least 30%
- Bitcoin exploded higher
- Housing stocks staged a big rebound (some did)
- Certain high-growth AI tech stocks rose 1,000%
Luke’s only prediction that didn’t play out was the call that small-cap stocks would outperform large caps. Instead, the AI Boom of 2023 lifted large-cap tech stocks to their highest levels in recent memory.
But the question now is what will happen tomorrow?
Before getting Luke’s thoughts, let’s get some perspective on today’s market.
We’re coming off a whopper of a bullish surge that saw all three major indexes explode higher between late-October and the end of the year.
As you can see below, between October 30th and the last trading day of 2023, both the S&P and Dow jumped 16%, and the Nasdaq climbed 19%. All three indexes are within striking distance of all-time highs.
But as we’ve covered extensively here in the Digest, this fantastic market performance has been based on hopes of Federal Reserve rate cuts later this year. This surge isn’t based on current fundamentals.
So, until rate cuts materialize, last fall’s bullish surge means one thing…
Stocks are very expensive.
Last week, MarketWatch compared current valuations with valuations from the bull-market peak in early January 2022
This is a fair comparison because all three major indexes are close to all-time highs.
The good news is that the U.S. stock market is a better value today than it was then. But here’s MarketWatch with the bad news:
Equities today remain more overvalued than at almost any other time in U.S. history…
[For example], the market’s current CAPE ratio is still higher than 90.1% of all monthly readings since 1881, according to data from Yale University’s Robert Shiller.
For newer Digest readers, “CAPE” stands for “cyclically adjusted price to earnings” ratio. It’s basically the same PE ratio that you’re familiar with, except it uses rolling 10-year average earnings to smooth out business cycle fluctuations.
Here’s a side-by-side comparison of nine separate valuation indicators analyzing the 2022 bull market high and today.
My colleague Luis Hernandez made a good point when reviewing this chart. He noted that this doesn’t provide us context for the market’s current valuation relative to long-term averages. So, it’s harder to get a sense of how overvalued we are.
To help with this, according to Multpl.com, the S&P’s long-term average PE ratio is 16.04. Its long-term average CAPE ratio is 17.07. And its long-term average price-to-book value ratio is 3.0.
So, our current PE ratio is about 50% higher than average… the current CAPE ratio is 88% higher than average… and the current price-to-book ratio is 50% higher than average.
To be clear, this does not mean the market will crash in 2024.
Expensive valuations mean nothing when it comes to market timing. After all, an expensive market can remain expensive (or grow more expensive) for far longer than investors believe possible. This reality led to the great investment maxim attributed to John Maynard Keynes: “The market can stay irrational far longer than you can stay solvent.”
Despite their timing imperfections, these valuation indicators still provide valuable perspective on the market’s future returns
For example, the CAPE ratio has proved quite valuable as a way to ballpark future 10-year returns.
Advisor Perspectives ran a study that looked at how well the monthly CAPE predicted future 10-year returns between January 1995 and May 2020.
From their results:
In a period where accounting rules changed and the 2008 global financial crisis decimated profits, CAPE explained 90% of the variation in 10-year returns…
CAPE’s ability to predict 10-year future returns during the last 25 years has been remarkable.
So, what can we learn about forward returns today using the CAPE ratio?
Back to MarketWatch:
Another way of putting the CAPE’s improvement in context is to construct a simple econometric model that uses the CAPE ratio to predict the S&P 500’s SPX inflation-adjusted return over the subsequent ten years.
At the January 2022 high, this model forecast a 10-year real return of minus 2.3% annualized; its comparable forecast today is a gain of 0.7% annualized.
While a gain is certainly better than a loss, this projected return is not enough to get too excited about. You can lock in a guaranteed return that is better — 1.7% annualized above inflation — with 10-year TIPS from the U.S. government.
Clearly, this isn’t the most bullish long-term forecast. So, if we’re to put any weight in it, then we want to focus on the sectors and opportunities that are most likely to continue climbing, despite this valuation headwind.
With this in mind, let’s return to Luke and his predictions for 2024
Here’s Luke with the corner of the market we need to be mining for outperformance this year:
Growth stocks absolutely crushed it in 2023, broadly soaring about 50% of the time while value stocks rose a measly 5%. And we’re confident that this trend will continue in 2024.
That’s because interest rates should move lower as the economic outlook improves – two major macroeconomic dynamics that strongly favor growth stocks. Plus, it’s also worth noting that the U.S. economy will likely pull off a soft landing in 2024, wherein interest rates move lower but economic activity remains positive.
The U.S. economy has achieved four such soft landings before. And every time, growth stocks meaningfully outperformed value stocks. Growth will likely remain the winning trade in 2024.
Now, let’s get more granular.
Within the broad bucket of “growth stocks,” where is Luke focusing for the highest-octane returns?
You guessed it – Artificial Intelligence.
Back to Luke:
It’s clear to us that we are in the first few innings of the AI Boom.
The best analog? The dot-com boom.
That period lasted from 1991 to 2000, almost an entire decade. And this AI Boom is just wrapping up its first year, which suggests there are still several years left in this boom.
We believe that over the next few years, AI will continue to proliferate across and transform the global economy. And AI stocks should remain the best performing stocks on Wall Street.
We are particularly excited about AI software, PC, server and robotics stocks for 2024.
If you’re looking for broad exposure to these trends, you have plenty of ETF options. For Artificial Intelligence, there’s the Global X Artificial Intelligence & Technology ETF, AIQ. For software, there’s the iShares Expanded Tech-Software Sector ETF, IGV. And for robotics, there’s the Global X Robotics & Artificial Intelligence ETF, BOTZ.
Of course, when investing in an ETF, you’re going to get plenty of underperformers too (not to mention some nosebleed expense ratios). So, if you’re looking to concentrate your investment capital in what Luke believes are the top picks in these sectors, click here to get his specific recommendations as an Innovation Investor subscriber.
Even though the market is pricy today, Luke’s prediction about the S&P is bullish
One of Luke’s 2024 forecasts is that the S&P will climb “at least 15%.”
With the market trading near its all-time high, and Wall Street pricing in double the amount of rate cuts that the Fed has hinted at, this level of gain might seem too rosy.
Fortunately, Luke details his rationale:
Current 2025 earnings estimates are around $270 per share. We think that strengthening economic momentum in 2024 will push those estimates higher throughout the year. And by the end of the year, 2025 earnings estimates will likely be north of $280 per share.
We also believe that stock market valuations should stabilize around their multi-year averages, which is about 19X forward earnings.
A 19X forward earnings multiple on 2025 EPS estimates of $280 implies a 2024 price target of 5,320 for the S&P 500. That’s about 13% higher than where the market currently trades.
And in bull markets like this, stocks tend to trade slightly above fair value. That’s why we think the whole market will rally at least 15% next year.
Putting it altogether, let’s go into 2024 open-eyed yet bullish
This is not a “cheap” market. And we’re on the tail end of an historic market surge based on a hope of what’s to come rather than what’s already here.
Plus, as it appears today, the market is finally returning to earth after being “overbought” for several weeks now. Perhaps we’ve begun the long-awaited correction that refused to materialize during the holiday season (Luke predicted we’d see this correction, and he sees it as a buying opportunity). Given this, we should be prepared for immediate market weakness in front of us.
But as regular Digest readers know, we prefer to view the stock market not as one huge monolith that rises and falls in unison, but rather as a “market of stocks” with wildly different fates and fortunes. And as we look out over 2024, Luke is especially bullish on growth stocks – specifically, AI, software, and robotics, even if there’s lingering broad market weakness.
So, let’s ride through whatever correction might be arriving, minding our stop-losses. But until the cardinal direction of this market changes, our default position is to follow Luke’s bullish lead.
We’ll keep you updated here in the Digest.
Have a good evening,
Jeff Remsburg
