U.S. stocks and bonds are heading into the new year with plenty of tailwinds that could broaden the rally, though risks to the downside remain.
"2024 is when we expect to see a meaningful broadening of stock market participation, as it's not healthy to have such a small number of heavily owned stocks drive overall market performance," said Michael Landsberg, chief investment officer of Landsberg Bennett Private Wealth Management.
The year 2023 started on the negative side for stocks, thanks to several headwinds like rising interest rates, the raging of the Ukraine war, and the growing tensions between the U.S and China.
But things quickly turned around in hopes of a Fed interest rate pivot, with all major equity averages posting solid gains by the year's end.
As of the beginning of the week, the S&P 500 is up 25% YTD; the Dow Jones is up 13.27%; the tech-heavy Nasdaq is up 44% and the small-cap Russell 2000 is up 17%.
The situation was slightly different for bonds. In the first part of the year, bull investors pushed bond prices higher in anticipation of an impending recession. But bond prices began falling in the second half of the year as the recession bond bulls expected never materialized before rising again on renewed hopes of a Fed pivot in the last six weeks.
All in all, bonds are ending the year with a yield of around 3.80%, the same as at the beginning.
Most of the gains in stocks followed a resilient U.S economy and the ease of inflation that reaffirmed the belief among traders and investors that the Fed has engineered a "soft landing." It's a tailwind, which could bring more gains in 2024 if the narrative comes true.
Meanwhile, the Fed's interest rate pivot could lower money market rates in 2024, prompting investors to move funds out of money market funds, another tailwind for equities and long-term bonds.
David I Kass, Clinical Professor of Finance at University of Maryland, believes that the rally in stocks and bonds will broaden in 2024, not only in the U.S., but also in Europe, too. In addition, he provides a good insight on the direction of interest rates and the U.S economy.
"The Federal Reserve's economic projections released on December 13 indicate a likely reduction in the Federal Funds rate from 5 1/4% - 5 1/2% currently to 4 1/2 - 4 3/4%, or three cuts of 1/4% each in 2024," Kass said. "Core PCE inflation is also projected to decline from 3.2% in 2023 to 2.4% in 2024. The historically low U.S. unemployment rate of 3.7% is projected to increase to only 4.1% in 2024."
Willer shares Kass' optimism on interest rates and the U.S economy, adding: "The broader markets are poised for a bullish 2024. Most economic reports look strong; inflation is slowly coming down, employment looks strong, and interest rates have likely topped and will soften, leaving the main bogey geopolitical for 2024 more challenging to quantify but not insignificant."
Juliann Gumulak-Smith, the founder of the Investment Academy for Women, is on the optimistic camp, too.
"As we head into the New Year, investors are putting the chance of a recession in the backseat and looking forward to the prospect of inflation continuing to come down, interest rates being cut, and having another stellar year in the stock market," she said. "There is renewed interest in adding more risk to your portfolio, including the potential in AI and having small-caps make a comeback for 2024."
Another tailwind for markets is the rapid deployment of AI systems. It could boost productivity worldwide, setting the world economy into a virtuous cycle of supply-driven growth -- a situation of higher economic growth and lower inflation.
But a few things can taper investor enthusiasm for taking further risks with equities and long-yield bonds, like geopolitical events in the Middle East and Asia, and the U.S presidential election.
Then there's valuation. Both equities and bonds have risen too fast, turning off value investors who refrain from chasing asset prices.
And there's some skepticism even among bullish equity analysts who think Wall Street is too optimistic about interest rate cuts in 2024.
"The stock market is too optimistic about the number of rate cuts expected in 2024, and we may be borrowing some of 2024's gains now as the year-end rally continues because we don't expect to see as many rate cuts as the market is currently predicting," added Landsberg. "We expect to see three rate cuts in 2024 starting in July and not any sooner than that unless something unexpected happens in the economy warrants lower interest rates."
