Will the Stock Market Crash in 2024? 7 Risk Factors
#2 of my series of articles this long holiday weekend giving investors a little heads up on what might be coming in 2024 in the markets and how to prepare for it. Merry Christmas!
DECEMBER 20, 2023
Invested
Advice, rankings and stock market news for investors.
Good morning, investors. Markets keep marching upward amid uncertainty over the start of potential rate cuts.
Highlights of today's newsletter include our market insights plus these new articles:
Despite no shortage of chatter about an inbound recession, the U.S. stock market is going to end 2023 on an upbeat note, with the S&P 500 index up 23.5% as of Dec. 18.
That's saying something given the downbeat vibe investors felt last January.
"2023 may go down in history as the year that defied all odds," says Kelly Milligan, managing partner at Quorum Private Wealth, a money management firm in San Francisco. "At the end of 2022, nearly every expert at the major banks predicted a recession and/or bear market in 2023. And yet, despite some volatility and selling over the summer, markets logged a largely positive year."
Still, few market mavens are predicting green lights and clear skies as the calendar turns to 2024. "The U.S. stock market is on shaky ground heading into the new year," says A.J. Giannone, chief investment officer at Allio Finance in Collegeville, Pennsylvania. "The good news over the past week has pulled forward most of the forecasted gain for next year and set up a scenario where any deviation from the 'Goldilocks' narrative could present a big problem for the market."
"With these rich valuations, we could be in trouble if the labor market suddenly shows signs of a meaningful slowdown," Giannone adds.
With inflation, rising consumer debt, stubbornly high prices for goods and services, a major U.S. election year, and two wars on the world stage, what's the outlook for a market crash in early 2024? Here's a closer look at seven key risk factors that will have an impact on the markets in 2024.
The labor market is the primary risk for the stock market going into 2024. Consumers are already suffering from higher prices after such a prolonged period of inflation.
"A sharp rise in unemployment would severely impair consumers and risk the market's ability to hit the lofty earnings predictions that are currently being forecasted," Giannone says. "Lower earnings revisions would be very challenging for a market that is currently pricing in a high level of general optimism."
One of the most important developments to watch in 2024 is the breadth, or the number of indexes, sectors, styles and individual stocks, that are participating in the stock market's uptrend.
"For much of 2023, a handful of large-cap tech stocks (the so-called'Magnificent 7') were disproportionately responsible for the year-to-date gains," says Thomas Samuelson, chief investment officer at Vineyard Global Advisors in Castle Rock, Colorado. "At the end of the third quarter of 2023, small-cap, mid-cap and the average U.S. stock were all down year to date, while the S&P 500 and Nasdaq were up largely due to their concentration in a small number of large-cap growth stocks."
An encouraging development in the fourth quarter of 2023 is the rallies being seen in small-cap, mid-cap, foreign developed and emerging-market stocks, as well as the average U.S. stock. "Yet, a bull market supported by a handful of stocks can only last so long," Samuelson notes, which makes for more uncertainty heading into a new year.
Inflation needs to show continued improvement, Samuelson notes. If it doesn't, additional interest rate hikes are more likely, which will present a headwind for stock valuations.
There are a few interesting data points on the inflation front that also bear watching. For instance, while consumer price index, or CPI, data for November show shelter costs increased 6.5% year over year, the real estate website Zillow's Observed Rent Index rose 3.3% over the same period.
"About one-third of the consumer price index is housing cost, a significant portion of which is calculated using an 'owners' equivalent rent' calculation by the Bureau of Labor Statistics," Samuelson says. "Well-known indices of market-based shelter costs – like the one published by Zillow – capture rents currently advertised on the open market versus units occupied by renters, as the CPI does."
Consequently, as the Zillow numbers attest, U.S. rent prices are falling much more rapidly than the CPI shelter costs. "The upshot is a further improvement (in the form of lower inflation) that is likely into 2024," Samuelson says.
The Federal Reserve's progress in rolling back inflation could stall at a level higher than its 2% target rate.
"This can happen if demand remains robust, and the labor market remains tight," says Niladri Mukherjee, chief investment officer at TIAA Wealth Management in New York. "The Fed may have to project a hawkish stance once again, which can lead to an increase in market volatility."
In November, the CPI rose by 3.1% on an annualized basis, while core CPI – which excludes food and energy prices – increased by 4%. The Fed has already indicated that it expects tocut interest ratesup to three times in 2024, likely by a total of 75 basis points. Furthermore, the Fed expects rates to slide by 250 basis points by the end of 2026, with a long-term policy rate of 2.5%, according to consultancy firm RSM'sReal Economy Blog.
"To bring down real rates, the Fed will need to cut its policy rate next year, which is implied in its new forecast," RSM U.S. chief economist and principal Joseph Brusuelas wrote on Dec. 13. "Federal Reserve Chairman Jerome Powell, though, was offered the chance to state this clearly and he avoided doing so. There is a long way to go before policymakers and investors can obtain a more precise identification of the policy path for next year and 2025."
With the Republican Party holding primary debates and the Democratic Party circling the wagons behind President Joe Biden, the 2024 election season is well underway. History shows that major election years have a significant impact on the financial markets, and 2024 should be no different.
"Going back to 1980, stocks have rallied in the year following an election, on average," says Greg Sweeney, chief investment officer at Bell Bank in Bloomington, Minnesota. "So while volatility may pick up with the unknown heading into an election day, stocks tend to forge ahead as uncertainty fades."
While the Fed is hitting the brakes on rate hikes (and yields tend to fall pretty quickly when that scenario occurs),market volatilityalready exacerbated by a huge presidential election could be further triggered.
"This means cash carries reinvestment risk, and today's elevated bond yields offer an opportunity to lock in higher income potential for longer," J.P. Morgan Wealth Management investment strategists Madison Faller and Shawn Snyder said in a recent research note. "We're most excited about municipal bonds, with their tax treatment offering an even bigger pick-up in yield alongside limited default risk."
High volatility in the financial sector presents another hurdle for the economy and the financial markets, particularly in two key areas: banking and real estate.
"The banking sector never really recovered following the collapse of regional banks kicked off by Silicon Valley Bank in March," Milligan says. "Traditionally, financial firms benefit from higher interest rates, but in 2023, many banks saw large losses in the 'hold-to-maturity' long-term bond portfolios."
This scenario triggered a domino effect that ultimately damaged banks' creditability in the eyes of their customers, who pulled their deposits, as well as investors, Milligan adds. That was a big reason why the regional banking sector was down about 8% year to date near the end of 2023.
Commercial real estateis looking for a rebound, too, given the widespread exodus from office leases as millions of employees work remotely.
"Public real estate investment trusts experienced double-digit declines driven by rapidly increasing interest rates and continued pressure on office space, thanks to ongoing remote-work arrangements," Milligan says. "Many private REITs struggled with liquidity gates, making it hard for investors to exit their positions."
While established officeholders know full well that a grumpy consumer base is a big problem in an election year, the stock market knows it may fare even worse if it can't count on the American consumer to pick up the slack in a downbeat economy.
For their part, consumers aren't on board with what politicians and corporate America are selling right now. "In the United States, slowing inflation supported an increase in confidence for much of 2023; however, this impulse has waned, and sentiment has stalled as persistently elevated prices continue to weigh on the consumer mood and signs of cooling in the economy emerge," Morning Consult noted in its"December 2023 Global Consumer Confidence Charts" report.
All that has translated into a slowdown in consumer spending heading into 2024.
"Consumer spending rose only 0.2% adjusted for inflation month over month in October, down from a solid 0.7% gain in September, for the slowest pace since May," the National Retail Federation, or NRF,wrote on Dec. 8, citing U.S. government data. "Households reduced spending on automobiles, furniture and clothing but expanded spending on travel, health care and housing."
Meanwhile, though consumer finances appear to be in "good shape," according to the NRF, storm clouds remain overhead. "Excess liquidity is shrinking and access to credit has become more expensive as banks have become more cautious in extending loans to consumers," the NRF noted. "The tightness of financial conditions has the effect of curbing the purchasing power fueled by job and wage gains."
What Should Investors Do as 2024 Nears?
With a mixed bag on the economic front and an encouraging end to 2024 on Wall Street, what moves – if any – should an investor make right now?
"We continue to tell our clients that it's critical to maintain their long-term strategic asset allocation, but that doesn't mean you can't be opportunistic as well," Giannone says. "Focus on allocations to defensive sectors or bonds as a way to insulate against some of the risks out there."
"Even after the recent pullback in yields, there are still compelling opportunities in fixed income for investors to earn strong yields without taking on the full risk of the stock market," he adds.
"In this market environment, investors should remain fully diversified across multiple asset classes and regions, in line with one's financial goals and risk tolerance," Mukherjee says. "Until the Fed's inflation mandate is reasonably within sight, factors such as high-quality, sustainable dividends, free cash flow generation and relative earnings strength are likely to lead."
As the stock market winds through a reset period for inflation, corporate profits and monetary policy at the end of 2023, "investors with longer time horizons may see opportunities to deploy excess cash into U.S. equities, especially as volatility picks up," Mukherjee notes. "In the near term, bonds are more attractive than equities from a total return perspective."
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