14/02/2024, 02:19 2024 U.S.

Stock Market Outlook: A Time for Balance

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2024 U.S. Stock Market Outlook: A Time for Balance

Jan 10, 2024

2024 is more likely to be an average year for markets than a double-digit winner. Find out why
and what it means for your portfolio.

Author

Lisa Shalett

Key Takeaways

The U.S. equity market’s rally at the end of 2023 has left stocks overvalued, with little room
for error.

Analysts’ estimates for 2024 corporate earnings may be too optimistic, given a likely
tapering in U.S. economic growth.

Markets may also be overestimating the number of Fed rate cuts in 2024.

Balance expectations and portfolios by buying the equal-weighted S&P 500 Index or
actively favoring value-style stocks, with a focus on financials, industrials, utilities,
consumer staples and healthcare.

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14/02/2024, 02:19 2024 U.S. Stock Market Outlook: A Time for Balance

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Investors are beginning 2024 at a precarious point. This mayRELATIONS
INVESTOR seem surprising, in light
MEDIA of recent
RELATIONS CLIENT
strong performance in equity markets. To understand why, consider where things stood at the
Our What About Why Careers
beginning of 2023: Investors were cautiously
Insightsoptimistic
Weabout the prospects
Us of cooling
Us inflation and
Do
interest-rate cuts, while still alert to the possibility of an economic recession and a dip in corporate
earnings.

As we know now, the economy blew past these cautious forecasts, supported by greater-than-
estimated consumer savings, more aggressive fiscal spending and looser financial conditions. The
upshot: a spectacular 25% advance in the S&P 500 Index for 2023, which put the benchmark back
near its record high from January 2022.

The setup today couldn’t be more different.

The market’s exuberant rally at the end of 2023 has left stocks overvalued, with investors especially
emboldened by the Federal Reserve’s December indication that rate cuts are on the horizon. When
investors have such lofty expectations, there’s little room for error.

Looking ahead, Morgan Stanley’s Global Investment Committee believes investors should have a
more measured outlook, with 2024 more likely to be an average year for markets than another
double-digit winner, given risks such as the following.

1
Excessive valuations
The S&P 500’s current forward price/earnings ratio is around 20, compared to about 17 at this time
last year. Meanwhile, the “equity risk premium”—i.e., the reward an investor can expect for owning
stocks over risk-free Treasuries—is at an extreme low of about 1 percentage point. While equity
valuations may give investors limited insight about what kind of returns to expect in the short term,
they are often accurate predictors of returns over a year or two. On that score, today’s valuation levels
point to sub-par annual stock returns, with gains averaging 4% compared to the long-run average of
7%-8%.

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2
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Vulnerable corporate earnings Do
Analysts currently estimate 2024 U.S. corporate earnings of about $242 per share, which assumes
companies will continue to expand their profit margins. But we think this consensus estimate is
overconfident, given a likely tapering in U.S. economic growth from last year’s torrid nominal pace of
about 7%, to about 4% this year. This decline would probably result in a loss of sales volume and pricing
power for companies. What’s more, corporations may have already recognized the benefits of factors
such as lower manufactured input costs and falling oil and raw material prices—meaning these
factors may be less likely to contribute to improved margins going forward.

3
Overly optimistic rate expectations
The market continues to assume that the Fed will cut rates more quickly and steeply than it has
publicly signaled: Despite the Fed’s signaled intent to cut rates three times this year, futures markets
are pricing more than six. That assumes the central bank will enjoy an uninterrupted victory in taming
inflation, whereas we believe inflation in labor-intensive services is still likely to persist.

4
Normalizing financial conditions
The Fed’s rapid rate hikes from March 2022 to July 2023 would typically have meant tighter financial
conditions. However, thanks in part to excess consumer savings, trillions of dollars in fiscal payments
and the fact that households and businesses had already locked in lower loan rates, liquidity in the
financial system has been ample. That said, loose financial conditions are set to reverse in 2024, as the
Fed winds down its 2023 emergency bank-lending program and as balances dwindle in its so-called
“reverse repo” facility, both of which have helped to keep cash sloshing around the system.

How to Invest for 2024

Given these four risks and our forecast for more modest returns from stocks, we believe 2024
should be a time for balance—for both investors’ expectations and their portfolios.
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14/02/2024, 02:19 2024 U.S. Stock Market Outlook: A Time for Balance

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Consider adding exposure to U.S. equities other than the market’s biggest, known as the
Our
“Magnificent 7,” by either investing in an What
equal-weighted About
version of the Why
market-cap-weightedCareers
S&P
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500 Index or by actively selecting stocks. Do

Maintain a preference for value over growth stocks. Financials, industrials, utilities, consumer
staples and healthcare are among the Global Investment Committee’s favored sectors, especially
until we see the first Fed rate cut.

This article is based on Lisa Shalett’s Global Investment Committee Weekly report from January 8,
2024, “2024 Outlook: Starting Points Matter.” Ask your Morgan Stanley Financial Advisor for a copy.
Listen to the audiocast based on this report.

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