EQUITIES COMMENT - 2023 in the Rearview Mirror- What's ahead for 2024?
Even though this is the part of the report where we write about equities, our first graph shows Canadian and U.S. 10 year federal government bond yields. Why? The decline in yields that took place from October to December is the main reason stocks rose sharply in the last quarter; the TSX Composite gained 8% while the S&P 500 increased 9% in Canadian dollar terms. For 2023, the TSX rose 12% and the S&P 500 23%. As we have discussed in previous comments, rising interest rates/bond yields put downward pressure on stocks. This quarter, we saw the opposite effect. The decline in yields reflected expectations that the Bank of Canada and the Federal Reserve will cut rates in 2024.
When we look at sector performance, you can see strength in Technology was the dominant theme in 2023. Tech-like stocks such as Amazon and Google boosted returns for the S&P 500 Discretionary and Communications sectors.
If we look at the performance of the Magnificent Seven (the seven largest stocks in the S&P 500—Microsoft, Apple, NVIDIA, Google, Meta, Tesla and Amazon) over a two year period, the 2023 gains look less impressive. These stocks were down substantially in 2022 and a big recovery took place in 2023. While higher interest rates weighed on Tech stocks in 2022, excitement about artificial intelligence overshadowed rates in 2023. You can see the big winner during this period was NVIDIA which manufactures the chips used for artificial intelligence applications. Sales and earnings for NVIDIA are booming. Telsa, Amazon and Google have not done as well as the S&P 500 over the last two years.
To finish off our sector comments, the laggards in 2023 were energy (falling oil and natural gas prices) and utilities (investors did not seek out companies that can withstand a recession or offer above average dividend yields). During the quarter, Utilities and other steady, dividend paying sectors rebounded as rate pressure eased. However, energy stocks had negative returns on both sides of the border. Softening demand for energy and increased production have deflated prices despite the Middle East conflict—good news for inflation.
There are a wide range for forecasts for stocks in 2024. We are forecasting a year end target of 22,000 for the TSX Composite and 5,100 for the S&P 500. This would produce gains including dividends of 8% and 9%, respectively. Earnings are predicted to grow between 6% and 8%. Valuations (p/e multiples) are expected to remain stable. There are numerous things that could go wrong or at least make the ride to our targets bumpier than usual.
The economy has held up much better than expected to higher interest rates. Normally, rising interest rates have a lagged negative impact on economic activity. Given the distortions caused by the pandemic, it could be the lag is longer than normal this time. If a recession were to occur, it would be negative for stocks as earnings could shrink.
Inflation is a key factor behind the recent decline in bond yields and central bank comments about rate cuts. Inflation has been declining steadily however, it remains above the central banks’ 2% inflation target. Higher wages are boosting inflation while lower goods prices are causing disinflation in some categories. Today, Saudi Arabia announced a price cut on its main oil exported to Asia due to rising supply. Oil plays a huge role in overall inflation so continued low prices should benefit the data.
Negative surprises for inflation could cause bond yields to increase and put some downward pressure on stock valuations, particularly for the S&P 500. U.S. stocks are trading in the upper half of the historical valuation range. On the other hand, Canadian stocks are in the lower half.
Unfavourable election results in Taiwan and the U.S. could diminish investor confidence, push down stock valuations and damage the economy if trade restrictions or tariffs are imposed.
The wars in Ukraine and Gaza are impacting trade and supply chains. This is putting upward pressure on inflation. Recent attacks in the Red Sea have caused an increase in shipping costs due to higher insurance rates and longer shipping times. The risk of a wider Middle East war that could affect oil production and transportation would also be inflationary.