Arguing for equities in 2024
Last year, investors who held a non-consensus bullish stance on equities saw their optimism rewarded as the market trended up through 2023. As we pivot into 2024, the outlook might appear to be more complex, but in reality, the preconditions remain the same: disinflation accompanied by positive economic growth.
Those preconditions have been positive for innovative growth stocks with pricing power, without exception, since 1978. I have no reason to believe this year will be any different. Indeed, the depressed price-to-earnings (P/E) ratios for small innovative companies could mean they outperform as they ‘catch up’.
But with the magnificent seven having again rallied strongly in early 2024, investors might be wise to brace for heightened volatility and moments that test the resilience of their bullish sentiment. Being ready to take advantage of any volatility – for example, by having your ‘additional investment’ form for the Montgomery Small Companies Fund ready to go (be sure to seek advice) – might make sense, given the compelling arguments suggesting equities could enjoy another prosperous year.
Argument 1: Retail flows
Pivotal and not-to-be-missed market moves often follow troughs and are marked by a transition from selling to buying. We saw this in the U.S. in November last year when flows into mutual funds and exchange traded funds (ETFs) turned positive, signalling confidence among retail investors. This shift, reminiscent of historical patterns, indicates a growing preference for equities over more conservative cash funds, hinting at a renewed period of support for equities.
Argument 2: Pausing rate hikes
We have frequently explained the arithmetic of interest rates through the present value of future cash flows formula. The product of the formula rises when rates fall. In other words, income-producing assets become fundamentally more valuable when rates fall. Meanwhile, the cessation of the U.S. Federal Reserve’s rate increases often precedes a favourable phase for equities. Following the fed’s last rate hike in July 2023, the market’s performance aligned with historical precedents for post-hike periods. Although rate cuts may not be imminent, their eventual introduction is strategic rather than reactive, further bolstering market confidence.
Argument 3: Easing inflation concerns
The cessation of rate hikes is fuelled by a gradual improvement in inflation metrics. And disinflation, as we have seen throughout history, can act as a tailwind for the stock market. The year-over-year comparison of inflation is expected to be favourable, especially early in the year. However, big falls in the rate of inflation will be harder to achieve as the year progresses simply because the comparison numbers from last year (comps) are already low. Nevertheless, as long as disinflation doesn’t reverse, the stage is set for supportive equity sentiment – especially equities in companies with pricing power.
Argument 4: Positive market breadth
A more tenuous signal that sentiment is shifting towards equities is market breadth. Market breadth turned positive in late Q4 2023, with 90 per cent of the stocks in the S&P 1500 Index moving above their longer-run average price. Some analysts claim such indicators reflect a shift from selling to buying among investors and broader support for the market’s upward trajectory. We’ll see.
Argument 5: Presidential election cycle influence
An intriguing pattern emerges in years when a sitting U.S. President campaigns for re-election, historically leading to a bullish phase for stocks regardless of the election outcome. Witness the recent example of a 30 per cent gain in the S&P500 following the last election when Trump was campaigning for re-election. According to U.S. investment bank Morgan Stanley, since 1944, this trend has consistently resulted in an average gain of 16 per cent for U.S. equities. Such years benefit from the incumbent’s potential to implement policies aimed at stimulating economic growth. Current policies, such as the infrastructure investment and jobs act, the CHIPS act, and the inflation reduction act, could play significant roles in maintaining economic vitality. I should add that the link between economic strength and stock market returns is weak. So, the election cycle relationship may be more about hope than actual economic advancement.
Argument 6: Earnings
Given the rally in equities in 2023, further gains may rely on earnings growth. According to Factset, for Q4 2023 (with 79 per cent of S&P 500 companies reporting actual results), 75 per cent of S&P 500 companies have reported a positive earnings per share (EPS) surprise, and 65 per cent of S&P 500 companies have reported a positive revenue surprise. For Q4 2023, the blended (year-over-year) earnings growth rate for the S&P 500 is 3.2 per cent. If 3.2 per cent growth transpires for the quarter, it will mark the second consecutive quarter the index has reported earnings growth.
While 2024 may present its share of volatility, especially if supply chains are disrupted by an expanding conflict out of Ukraine and the Middle East, the earnings, economic and investor backdrop appears supportive. Additionally, historical precedents provide a foundation for continued optimism.
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
