2024 Midyear Outlook
July 18, 2024
Following a robust 24% gain in 2023, the S&P 500 has continued its upward trajectory in 2024, posting a commendable 17.48% gain as of July 18th. However, bonds have faced another challenging year, with returns ranging from -0.36% to -4.37%, depending on maturity. The S&P's current valuation, with a P/E ratio of 22, is approximately 30% above the historical average of 17. Despite this, healthy earnings growth and solid economic data justify the higher valuation. Wall Street analysts predict earnings for S&P companies will grow by over 10% in 2024 and 14% in 2025, driven by solid revenue growth and steady margins. This optimism is reflected in the upward revisions of earnings guidance. Additionally, the IMF forecasts a 2.7% expansion for the US economy this year, compared to 0.8% for Europe.
Although inflation hasn't hit the Fed's 2% target, it has been trending downward. A more realistic target would be around 2.5%, the average rate over the past 20 years. The year-to-date inflation rate for the first six months of 2024 stands at 2.42%. We have seen significant disinflation since the pandemic's peak inflation period. The term "inflation is sticky" is misleading; "prices are sticky" is more accurate. We don't want prices to fall, as that would indicate deflation, which is detrimental to the economy.
While the media attributes the Federal Reserve's decision not to lower interest rates to maintaining credibility, I believe it's simply because we're not in a recession. The Fed should not lower interest rates unless we enter a recession. Lowering rates just because inflation meets the Fed's target is illogical. In the event of a recession, the Fed will have more tools to combat it and should not deplete its resources prematurely at the behest of capital markets, particularly bond managers coming off three years of negative returns.
The inverted yield curve, often a predictor of recession, isn't garnering much attention. Despite the general belief that "the market knows best" and "the market is a forward-looking mechanism," we won't know until early next year if we're in a recession. Betting on a Fed rate cut this year is misguided. The market has significantly reduced its expectations for a rate cut, though many still anticipate one as early as September. Forecasting is challenging, and if the market doesn’t meet expectations, investors may react negatively even if earnings are healthy. The market must not only be fundamentally sound but also meet these expectations, adding more pressure. I believe this rate cut anticipation is the biggest risk to the market today. When the yield curve eventually normalizes, long-term bond investors may face another round of negative returns. Given this outlook, an unorthodox approach to asset allocation is prudent. I recommend staying short duration in bonds (less than 1 to 2 year maturities) and avoiding long-dated bonds in favor of sustainable dividend-paying stocks, such as SBUX, GIS, JNJ, and PEP, which offer both income and potential capital appreciation, along with better tax efficiency compared to bonds.
As a long-term advocate for dividend-paying stocks, I welcome the trend of technology companies initiating dividend payments to shareholders, with notable dividend growth rates. For example, TXN offers a 2.62% dividend yield, with five- and ten-year average dividend growth rates of 13.80% and 16.72%, respectively. This means that if these growth rates persist, in 5 to 10 years, today's stock buyers will receive yields of 4.82% and 11.84%, respectively, illustrating why some stocks are considered an effective hedge against inflation.
Based on my calculations, while the S&P is overvalued by about 10%, a healthy economy and growing corporate earnings support the current valuation. However, since future earnings growth is already priced in, I don't expect significant broad market increases from this level; rather, it will likely be range-bound. As I indicated earlier, the anticipation of rate cuts this year is probably the biggest risk to the market today. For this reason, opportunities lie in selective stock picking, which will be crucial for portfolio differentiation.
Looking ahead, if President Biden (or another Democratic candidate) triumphs in November, with the majority of $7 trillion in unspent economic rescue funds, $6 trillion in money market funds, and healthy earnings growth backed by a strong economy, I foresee gradual valuation expansion in sectors such as renewable energy, industrials, telecom, manufacturing, and technology, particularly AI. However, if Trump takes the White House, I foresee less regulation, benefiting banking, healthcare, and oil & gas industries.
Alpha Capital Wealth Advisors, LLC is a registered investment adviser. Informaon presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless
otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.
