Now in the early days of 2024, investors are gearing up for another year of market volatility and interest rate surprises.
Tim Murray, capital markets strategist – T. Rowe Price, has identified some key themes for investors to keep an eye on.
The “magnificent seven” are viewed as a separate asset class
The year 2023 bore witness to one of the most top-heavy equity markets ever, Mr Murray noted.
But the reality, he added, is that US stocks are not broadly expensive.
“Rather, the aggregate valuation of US stocks is distorted by the high valuations of these seven ‘mega-caps’ companies that make up nearly 30 per cent of the S&P 500 Index,” he said.
Namely, these seven mega-caps constitute Apple, Microsoft, Google parent Alphabet, Amazon Nvidia, Meta Platforms, and Tesla.
Mr Murray said investors may be quick to assume that valuations of the magnificent seven are unreasonably high, rather, the high valuations that these companies hold are accompanied by a similarly high return on equity (ROE) on a market cap-weighted basis.
“The bottom line is that the elevated valuations of the magnificent seven collectively, and US stocks in aggregate, are not unreasonable when taken in context,” he explained.
What remains to be seen, he warned, is whether the level of profitability and efficiency that these seven companies have exhibited can be sustained moving forward.
The Fed does a 180
One of the most notable developments of 2023, Mr Murray noted, came at the Federal Open Market Committee’s (FOMC) December meeting, where it delivered a surprisingly dovish signal.
Fed chairman Jerome Powell has spent most of 2023 reiterating the Fed’s intention of prioritising fighting inflation over supporting the economy for the foreseeable future.
“But in December, the Fed changed its tune,” Mr Murray explained.
“First, we got a dovish set of forecasts in the Summary of Economic Projections. Then, in the post-meeting press conference, Powell told us that they would be giving equal attention to their two mandates – fighting inflation and supporting the economy – going forward.”
Namely, the latest Summary of Economic Projections showed Fed officials pencil in 75 bps of interest rate cuts in 2024, up from 50 bps previously, and a further 100 bps of cuts in 2025.
“This is a big deal. We spent 2023 fearing that the impacts of tight monetary policy would drag the economy into recession. Happily, that did not happen – and a more dovish Fed means the likelihood of recession in 2024 has fallen considerably,” Mr Murray added.
Yield is back
After an extended period of extremely low yields in bonds, yields have finally rebounded, Mr Murray explained.
Now that the Fed has signalled its intention to cut rates in 2024, however, it is projected that yields will drift lower.
“But we should not expect a return to the anemic levels of the 2010s, as long as inflation remains a threat. This means that current yield can once again be a useful feature in bond portfolios as we move into 2024,” Mr Murray said.
