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NEW YORK (Reuters) – Investors’ expectations for the start of 2024 are high, sending U.S. stocks into a tailspin if some expectations are not met.
Despite the rough start to the year, the S&P 500 is only about 2% off a recent record high. Most investors maintain a positive outlook on everything from the U.S. economy and corporate profits to the Federal Reserve’s monetary policy trajectory.
For example, the story of resilient growth and gradually declining inflation that helped propel the S&P 500 to a 24% gain last year has become the consensus among investors.
The latest BofA Global Research survey released last month showed that 66% of fund managers believe the economy will achieve a soft recovery in 2024. Only 15% of fund managers expect a recession in the next 12 months, BofA data shows, a sharp contrast from a year ago, when 68% of investors feared a recession.
Bets on easy monetary policy have gone along with the soft landing outlook. Futures tied to the Fed’s policy rates indicate to investors an interest rate cut of about 140 basis points this year, almost double the central bank’s estimate.
Not surprisingly, many investors have a positive outlook on stocks. The survey by the American Association of Individual Investors showed that bullish sentiment rose to 48.6% in the latest week – down one notch from its recent peak in December, but well above the historical average of 37.5%.
After policymakers surprised markets with a dovish stance last month, those views have been largely shaped by solid evidence of subdued inflation, a comparatively strong economy and the Fed’s own guidance. However, with stocks near historic highs and at elevated valuations, some investors worry that the market’s rosy outlook leaves more room for disappointment if either of those scenarios materialize.
“Anything that defies the current economic narrative or the market narrative – the risk of that pessimism having an impact on prices in equities is high,” said Yung-Yu Ma, chief investment officer at BMO Wealth Management.
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A test of investors’ optimism comes with next week’s consumer prices data, which could show whether recent bets on a decline in inflation have been premature. Expectations of a cooling economy that could set the stage for a Fed rate cut took a hit on Friday, when jobs data showed that employers hired more workers than expected in December, while wages grew solidly. Had happened.
The S&P 500 fell 1.54% this week, its biggest weekly decline since late October.
Major banks including JPMorgan Chase and Citigroup begin earnings season next week, testing elevated expectations for corporate profits. Analysts expect S&P 500 earnings to rise 11% in 2024 after rising just 3% in 2023, according to LSEG data.
The pressure to meet higher earnings targets may be more intense than a year ago, as overall market valuations have climbed. The S&P 500 trades at a forward price-to-earnings ratio of 19.5 times, compared with about 17 times in early 2023, LSEG Datastream data shows.
“We don’t expect multiples to rise significantly from here because valuations are a bit stretched, so it will come down to where earnings come in,” said James Ragan, director of wealth management research at DA Davidson. Ragan puts the fair value for the S&P 500 at 4,700, roughly where it is trading now.
Looking ahead, investors will analyze the Fed’s message at the end of its Jan. 30-31 policy meeting. The market expects the central bank to make no changes to rates this month, and has reduced bets on a rate cut at its March meeting. CME’s FedWatch tool showed the futures market on Friday had about a 62% chance the Fed would cut rates by 25 basis points in March, up from about 73% a week earlier. Still, stocks have historically responded well to rate cuts. According to Ned Davis Research, in the last 12 easing cycles since 1970, the S&P 500 has rallied with an average gain of about 12% in the six or seven months following the first rate cut.
Keith Lerner, co-chief investment officer at Truist Advisory Services, said in a recent note that the extent of positive surprises has increased and he expects a “digestion period” for the market after the strong run. However, he still believes there is potential for the stock to rise in 2024.
“Stay tuned to the underlying positive market trend and be prepared to use pullbacks as opportunities,” Lerner said.
(Reporting by Lewis Krauskopf; Editing by Ira Iosebashvili, David Gregorio and Leslie Adler)