Annualised performance data in euros as of 31st December 2023

As we approach 2024, we expect both inflation data and economic demand to soften, as the tailwinds for growth and risk markets are fading.

Overall, we are cautious about the performance of risky assets and the broader macro outlook over the next 12 months, due to building monetary headwinds, geopolitical risks and expensive asset valuations. Looking ahead, assuming the US economy grows by 1%-2% in real terms and inflation bottoms out at 2.5%-3.0%, US companies should be able to grow top-line revenues by 3.5%-5.0% in aggregate.

As inflation falls, corporate margins should feel less pressure from rising input costs, wages, etc. If margins are flat year/year, corporate earnings can deliver 3.5%-5.0% growth after tax. If we include an additional potential benefit of 1%-2% growth from share buybacks, then we get to 4.5%-7.0% net earnings growth in 2024. The key question becomes: what multiple of earnings will investors pay for companies that deliver mid-single-digit earnings growth in 2024? Price/earnings multiples swing widely over time. When investors are optimistic, they often pay over twenty times earnings for individual companies. Pessimistic investors are reluctant at times to buy stocks trading at ten times earnings.

An alternative way to look at stock market valuations is to measure equities relative to the size of the local economy. For example, the S&P 500 currently trades at 0.16 times US GDP. This places US equities in rarefied air, above the prior bull market peaks of 2000 and 2007. Equities were only more expensive versus US GDP heading into the (possible) bull market top in 2021.

January 2024 Equities

Perhaps, all is not what it appears at first glance. Thanks to the powers of passive investing and the very strong performance of the technology sector over the years, the top seven stocks in the S&P 500 now account for 28% of the index, with the remaining 493 stocks accounting for 72% of the index. These companies are incredibly profitable businesses and hugely successful. Their valuations reflect this performance. In aggregate, they trade at close to fifty times earnings. Together, Apple, Microsoft, Amazon, Alphabet, Nvidia, Meta and Tesla have a higher weighting in the MSCI World Index than all of the stocks in Japan, France, China, and the UK combined.

If we look at a broader index, valuations are less stretched. The NYSE Composite Index for example, includes over 3,700 stocks and is a much better reflection of the US economy. The NYSE Composite has traded in a range of 0.3 times US GDP to 0.7 times US GDP over the last thirty years. Today, the NYSE Composite trades at 0.58 times US GDP; above average, but not excessively so.

January 2024 Equities

We can conclude that parts of the stock market are certainly overvalued, but not all sectors. Value stocks have underperformed growth for years. Perhaps we will see some rotation into the cheaper and more defensive sectors of the market in 2024. If we get a weaker US dollar, which is expected as part of the Powell pivot process, stock markets outside the US should also do well. Brazil, Japan, and emerging markets (ex-China) look promising. It will certainly be a year of increased market volatility, particularly if inflation does not behave and long bond yields start rising again. We also have a contentious US presidential election in November.