Bullish or Bearish: My Analysis

By John Lau, CPA, CFP®

December 4, 2023 – In a call with a long-time client yesterday, he asked where I thought the market is heading, and whether I am bullish or bearish going forward. I think this may be a question in many people’s minds, so I want to take this opportunity to address it here in today’s commentary:

At this time of year, Wall Street firms are updating their 2024 S&P 500 targets, so it may be helpful to lay out the bull case underlying positive forecasts, the bear case underlying negative forecasts, and my personal analysis.

Case for the Bulls: The bullish argument for stocks can largely be summed up by this statement: Everything that’s already priced in actually happens (i.e., no economic slowdown; inflation continues to decline; no hawkish surprises from the Fed; and no reduction in earnings.) I say that because most of the year end 2024 S&P 500 price targets are in the 4,700-4,800 range, which reflects some modest upside from current levels (at the time of this writing, S&P is at 4,594.) The 2024 macroeconomic environment will allow the S&P 500 to trade around 19X 2024 earnings ($245/share), which equates to somewhere between 4,655 (19*$245) and 4,778 (19.5*245) and this logic and math is how most Wall Street strategists are coming up with their 4,700 price target. Put differently, for this bullish belief to be true we need to see all the positive expectations that were pulled forward in 2023 actually happen. And if that’s the case, we can expect between a 2% and 5% return in the S&P 500. Frankly, that is not the most riveting or exciting bull case, because buying stocks for a 2%-5% return when I can get 5% in a high-yield savings account with zero volatility isn’t exactly attractive.

Case for the Bears: The bearish argument for stocks can largely be summed up by this statement: Everything we were worried about for 2023 (when most analysts were bearish) actually happens in 2024 (economy contracts; inflation stabilizes but does not decline further; the Fed does not cut rates as expected; and corporate earnings growth disappoints). I say that because a lot of the 2023 rally in stocks can be explained by a “not as bad as feared” situation, and not a series of materially positive surprises. So, for stocks to roll over from here, all that has to happen is that the worries of 2023 occur, because all remain possible. The market is currently pricing in nearly 10% earnings growth from 2023 to 2024, but given the looming economic environment, that earnings growth may be too optimistic. Earnings growth will disappoint as companies face a slowing economy and run out of room to cut costs, absent layoffs (which would deepen the economic contraction).

What’s my personal analysis? In my view, stocks are overvalued in the current economic environment.  While this macroeconomic environment doesn’t necessarily mean an epic market collapse, it does mean that investors may be too optimistic, and the concerns of 2023 weren’t misguided, they were just early. From a market performance standpoint, because the environment above is what was expected at the start of 2023, we can look to where the S&P 500 started 2023 as a guide. The S&P 500 started 2023 just under 3,800, so I think that’s a reasonable downside target for the S&P 500. That would represent a 16% decline from current levels. And while that may seem like a long way down, it was about a month ago that the S&P 500 was flirting with breaking 4,000, and the only thing that’s changed since then is that the market is aggressively pricing in its current belief that the Fed will be more dovish than expected. If that expectation is reversed and we have a growth contraction, the S&P 500 at 4,000 may again be tested.

I want to be clear that I am not a raging bear. The Fed balance sheet, a still relatively strong consumer, and strong employment are all positives that should help cushion any substantial drop in growth. But I will say that I am concerned that, in part due to the calendar and the push for a year-end rally, this market is now susceptible to disappointment in early 2024, not unlike it was following 2021 where stocks melted up into year-end only to be smacked across the face once the calendar rolled and they had to confront high inflation, slowing growth and a hawkish Fed. I don’t think this reaction will be that bad, but it does give me pause to see how markets are embracing the precipitous fall in Treasury yields right now. If that drop is the result of slowing growth and economic data begins to signal weakness, falling yields will be a warning sign of a looming economic slowdown, something that is not at all priced in with the S&P 500 at 4,500. The net result, I believe, will be more volatility, especially in the beginning of the year as investors acknowledge a slowing economy and a less dovish-than-expected Fed, and a return of September/October type declines shouldn’t shock anyone.

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