Wall Street Bets the Fed Will Keep Stock Rally Rolling in 2024

Major stock indexes finished 2023 near record highs, encouraging investors to set high — and maybe unrealistic — expectations for 2024.

Strategists expect the Federal Reserve to perform some sort of economic jujitsu next year that brings the U.S. economy in for a so-called soft landing, where it slows growth without spurring a recession. To do that, they predict the Fed will make at least three interest-rate cuts next year while simultaneously cooling inflation — two things that almost never happen together. They're also betting that corporate earnings will continue to grow — despite a slowdown in China and tumult in the Middle East and Eastern Europe.

Stocks opened mixed on the first trading day of the year, with the Dow Jones Industrial Average slightly up and S&P 500 just barely in the red.

"After a strong 2023, investors should temper expectations for 2024 as earnings estimates look lofty, volatility has been unusually low, valuations could come under pressure and economic growth is likely to slow," JP Morgan Asset Management strategists said in their 2024 Year-Ahead Outlook.

JP Morgan's forecast is on the low end, predicting the S&P 500 will end 2024 at around 4,200 — down about 12% from the 4,770 mark where it closed on Friday.

On the upper end of expectations for the market is Tom Lee, managing partner and head of research at Fundstat, who sees the S&P rising about 9% to 5,200 by the end of 2024.

At the beginning of 2023, when most prognosticators were predicting a recession and sluggish stock market, Lee said the S&P would end the year at 4,750, which proved the most accurate stock market prediction of the year.

The idea that the S&P could finish 2023 with a gain of more than 24% was then almost laughable. Now, Lee continues to bet on a soft landing for the economy, interest rate cuts, strong corporate earnings and further declines in inflation and he isn't alone this year.

Oppenheimer's 2024 forecast also sees the S&P finishing at 5,200.

Citi, Deutsche Bank, BMO and Goldman Sachs are all calling for the S&P to end up around 5,100 by year-end — close to a 7% gain.

It's important to remember, most economists and Wall Street analysts were way off in their 2023 predictions, whether it was forecasting a recession that never came, or insisting that inflation might not come down meaningfully over the year.

Many of them are now as convinced of a soft landing this year as they were of a recession last year.

Record Highs

Some market observers, however, worry that the big gains to come from a perfect landing have already been taken.

Lower inflation, Fed cuts, strong earnings and a resilient economy have already been priced into the market. Record highs don't always leave room for immediate improvement and any disruption to expectations could send the market tumbling.

"We believe the first quarter of the year could be a struggle," said Alex McGrath, chief investment officer for NorthEnd Private Wealth in Greenville, S.C. in a recent note. 

He sees consumers, whose spending accounts for about two-thirds of the U.S. economy, losing strength in the months to come.

"The excess savings days of the pandemic are well in our rearview," he wrote. While inflation may be slowing, he said that doesn't reflect the fact that everything is "20% to 30% more expensive than it was two years ago." 

"Student loan payments have restarted, credit card debt is at an all time high while the interest on that debt is also at an all time high," he said, adding "spending has to eventually break down from its torrid pace."

Soft Landing

Darrell Cronk, chief investment officer for Wells Fargo Wealth & Investment Management, isn't expecting much from the market, either. He sees economic growth slowing to 0.7% for 2024, down significantly from the 4.9% growth it enjoyed in the third quarter of 2023.

His target for the S&P 500 is between 4,600 to 4,800 for 2024, about where it is today, even with the two Fed rate cuts he expects.

The first half of the year, he says, will be dicey for the market as the economy slows, but he sees a turnaround in the second half of the year.

"Once investors begin to anticipate an economic and earnings recovery, WFII expects the S&P 500 Index to gain into year-end," he wrote in his 2024 outlook.

Michelle Cluver, a portfolio manager at Global X in New York City, says the soft landing that many investors have come to expect could feel a bit hard.

"The difference between a soft landing and a shallow recession is very small," she said.

When the Fed finally cuts rates, it may not be because its inflation fight has completely ended, but because the economy has landed hit the ground.

"One of the worst environments for stocks is the economy shrinking and the Fed cutting," she said "That’s the kind of environment where we’d expect fixed income to do well, but not equities."

Charles Schwab strategists also say the expected rate cuts might not be the best news for the market.

"It may be the case that if the Fed is cutting rates by mid-2024, it's because of further deterioration in the economy — specifically the labor market," Schwab's Chief Investment Strategist Liz Ann Sonders and Senior Investment Strategist Kevin Gordon wrote in their 2024 outlook. "In fact, one of our key expectations for the year to come is that the Fed will begin to shift its focus from the inflation side of its dual mandate to the employment side of its dual mandate.”

Room for Optimism

A lot has to go right for the most bullish projections to prove true.

Serena Tang, chief global cross-asset strategist at Morgan Stanley Research, says that the best hopes for rate cuts and the economy are already baked into the market. She sees better opportunities in government bonds and high-quality fixed-income investments as the world waits to see if that soft landing actually happens.

Fixed equity and bonds are delivering higher yields with not as much risk as the equity market.

"Central banks will have to get the balance correct between tightening just enough and easing quickly enough,” she wrote in her 2024 outlook. “For investors, 2024 should be all about threading the needle and looking for small openings in markets that can generate positive returns.”  

If interest rates come down as expected, though, market gains are expected to broaden beyond the so called "Magnificent Seven" stock that delivered most of the S&P's 2023 gains: Nvidia, 239% in 2023; Meta platforms, 194%; Tesla, 102%; Amazon, 81%; Alphabet, 58%; Microsoft, 57%; and Apple, 48%.

Lower interest rates will boost the performance of smaller-cap companies if the economy maintains its resilience, as expected. These expectations already pushed the small-cap Russell 200 Index up 15% in 2023.

Adam Turnquist, chief technical strategist for LPL Financial in Charlotte, N.C., says this broadening-out of the market could keep the rally alive, even if stocks do get a little too pricey.

The pattern for both the economy and the stock market in 2023 has been a series of surprises to the upside, and the best guesses have proven too pessimistic. Perhaps that pattern will continue into 2024.

"We’ve been pleasantly surprised by the resilience of the consumer and how well the stock market has performed in 2023, so we have to be a bit less pessimistic heading into 2024," said Chris Zaccarelli, chief investment officer for Independent Advisor Alliance in Charlotte, N.C.

Peter Essele, senior vice president of investment management and research at Commonwealth Financial Network in Waltham, Mass., also says it's tough to discount the continued strength of the economy and the rally.

"Despite recession fears, 2023 was a surprisingly robust year for the economy," he wrote in a 2024 market outlook report. "We expect the positive trends to continue in the new year, which should support continued financial market performance. But that doesn’t mean the road ahead will be smooth."