“If you do not expect the unexpected you will not find it,
for it is not to be reached by search or trail.”
c. 500 BC
Against the odds and predictions of many economists, the US economy and stock market ended 2023 ahead of expectations, avoiding a much-anticipated recession and delivering strong equity returns. For the full year, the S&P 500 gained some 24%, the DJIA 14%, and the NASDAQ an eye-popping 43%. And despite early pessimism, exacerbated by a near-crisis among regional banks in March, equity market performance was relatively consistent—that is, upward moving—throughout 2023 (Figure 1).
But with the prior year quickly fading in the rearview mirror, it is time to begin looking ahead to this year which, no matter how you cut it, is bound to be an interesting one. To wit, the Federal Reserve must contend with easing monetary policy while keeping a lid on inflation; the stock market, coming off a banner year, may need to start producing outsized earnings growth to justify currently lofty valuations; and the economy, which so many prophesized would fall into a recession in 2023, will hopefully continue to expand. Fortunately, historical economic data—including last year’s performance—can provide some insight into these factors and, in turn, perhaps the future direction of markets as well.
As we have written about in the past, a portion of the year-over-year change in Gross Domestic Product (GDP) can be estimated from other key economic factors, including equity market returns, changes in Treasury bill rates, and actual prior GDP outcomes. While not an exact measure, such determinants provide a rough guide for future economic performance and, despite looming challenges, 2024 appears to be on track for modestly positive economic growth of about 1.5% (Figure 2).
Bear in mind that the chart above depicts a rate of change; while it looks as though GDP may have fallen from its near-term peak in 2021, the US economy has still grown on an absolute basis, just at a slower rate.
Another important rate of change worth considering is the Consumer Price Index (CPI), the most commonly referenced gauge of inflation. Like GDP, a positive CPI figure denotes an absolute increase in value from the previously measured period; though the percentage change in CPI may be lower than before, that does not signify that prices have necessarily come down (which would be deflation). Inflation has been a widely discussed topic over the past few years, as supply chain disruptions and other factors caused broad-based increases in the price of consumer goods, from food and fuel to housing and services. Looking ahead, changes in key economic indicators show the pace of inflation should continue to slow from the 2021-22 peak to an estimated 3.6% in 2024 (Figure 3).
Milder inflation, combined with positive—albeit below average—GDP growth, underpins a relatively stable economic outlook for 2024, and in turn, hopefully a much-needed relief from volatility, which has stoked sharp swings across markets in recent years. Indeed, the S&P’s average annual return of ~8% since 1965 falls well below last year’s performance. Further, the index has delivered sequential double digit annual gains just seven times over the same period, suggesting a reversion toward mean performance is the most likely outcome this year.
Consensus appears to agree that, while not a “blow-out” year by any means, 2024 should maintain the status quo set in 2023 as markets (and consumers) continue to adjust to higher levels of prices and interest rates—the latter of which could start to come down once the Fed is reassured by the state of the economy.