In January, we had mostly positive performance for stocks, while bond performance was slightly negative. From an economic perspective, there is an increasing belief that we can avoid a US recession in the near term while the Federal Reserve begins to lower interest rates as a result of normalizing inflation rates. If this situation occurs, it is relatively unique in history but not unprecedented. Also, it represents a very favorable backdrop for the stock market.

Let’s begin with the economy. Economic trends remain relatively positive overall. This is evidenced by continued growth in US GDP, a job market that remains resilient, and inflation rates that are decelerating toward levels that are more normal with long-term history. So, any reports of US demise are largely overstated and not based in reality. However, this does not suggest there are no clouds on the horizon, but as of now, we have a difficult time suggesting that the US is headed toward recession in the near term.

So, with this level of economic resiliency, it has been our opinion that the US Federal Reserve is more likely to be in a period of pause and reflection rather than near-term action. We expect that the US Fed wants to ensure that inflation is controlled before undertaking actions that they may need to reverse later. They would rather see the writing on the wall first. That is why we were perplexed by the market expectations of interest rate cuts beginning in March. If our economy is growing, and inflation is coming under control but isn’t at the desired level (yet), then we don’t understand why the Fed would pre-emptively act. Our outlook has gone from being a minority viewpoint to the consensus opinion, and one that was largely confirmed by Fed Chairman Powell in a recent commentary. 

January also had many companies reporting their earnings from Q4 2023 and providing initial outlooks for 2024. I would characterize earnings as more of a mixed bag of positive and negative trends rather than a clear direction either way. We still have a majority of companies in the S&P 500 beating their earnings estimates, but outlooks have been more cautious than consensus expectations. This, however, is not unique. Wall Street often plays the game of lowering expectations early in the year in the hopes that they can beat these expectations down the road. It has been our estimation that expectations for 2024 earnings growth were too high, and these recent trends are getting things closer to reality than they were before. 

At Gradient Investments, we follow the fundamentals of economic trends, business health trends, and valuation (or what we are paying for stocks). As shown above, economic trends remain resilient, and consumers are still spending money. This is the lifeblood of our economy. While earnings are more mixed than abjectly positive or negative, 2024 earnings should still be expected to grow in the mid-to-high single-digit range. These are both positive trends for market performance. 

Valuation, on the other hand, is the more negative story as the S&P 500 is relatively expensive compared to its history. Valuation, however, is not a good predictor of near-term market changes. Expensive can get more expensive, and cheap can get cheaper. Historically, valuation is a better predictor of long-term market growth, and while current levels aren’t at “red line” territory, we would expect that long-term stock returns might be slightly below average as a result of a premium valuation now. 

For investors, we suggest understanding and evaluating your current risk levels. After a strong rally in stocks since October, it makes sense to re-examine your current level of risk to ensure it is still fitting with your long term investment plan and is within the bounds of your risk tolerance. Taking profits to protect some of the recent gains and rebalancing back to original risk levels is often a prudent strategy.  This doesn’t mean wholesale changes or selling all stocks based on fear of pending doom. We don’t find doom and gloom to be a viable market strategy. Rather, being flexible and open to opportunity while still having some level of protection for difficult markets is still the most viable strategy for achieving your long-term investment goals.