As US stocks approach new highs and the odds of a recession look less and less likely, stock market bears continue to forecast a host of market-impacting disasters imminent.
I expect the US market to end this year 5% to 10% higher, for three main reasons: no recession; Inflation will continue to deflate, and cautious investors will enter the market and push stocks higher.
However, it is always good to understand opposing viewpoints. With that in mind, here's a look at five major fears that market naysayers have — and why they'd be wrong. Markets can correct at any time (a 10% drop), but it is unlikely that another bear market (20% drop) is on the horizon.
1. 2024 brings recessionStock markets hate recessions. So, this will be bad for the bulls. It's a bit scary that no less than veteran market gurus Jeffrey Gundlach and Bob Dole predicted this outcome. Their exhibit A: The inverted Treasury yield curve – the difference between 10-year US Treasury yields BX:TMUBMUSD10Y and 2-year US Treasury yields BX:TMUBMUSD02Y, which always predicts a recession.
But that's why they'll be wrong this time. Inverted yield curves predict recessions because they correctly predict that monetary tightening will lead to a credit crunch. This in turn sparks a financial crisis that destroys the economy and stocks.
The problem is that we have already faced the financial crisis. It was a mini-collapse of the regional banking sector in the first half of 2023. We got through that because the US Federal Reserve dealt with it. The Federal Reserve has flooded US banks with liquidity through its bank term financing program. Now we have gone even further, except for those who cling to a “hard landing” scenario.
Meanwhile, market interest rates fell, relieving pressure on the credit system. Lower rates are also a form of economic stimulus. The Federal Reserve will soon begin cutting short-term interest rates, to continue this trend.
Beyond the credit crunch, the real thing to watch in the coal mine is trading activity, notes Mark Zandi, chief economist at Moody's Analytics. “Companies are the first to point out there is a problem because they are holding back salaries and investments,” he says. This would undermine consumer sentiment, creating a vicious cycle of weak demand and risk of layoffs.
“At the moment, there is no indication of that,” Zandi adds. “Businesses remain steadfast in their refusal to lay off workers and rein in investment. The economy continues to perform well, and the outlook is improving with inflation falling without an increase in unemployment.
Moreover, the United States is in the midst of a productivity boom that will continue due to rising business investment in new technology and equipment. Increasing worker productivity increases profits and relieves pressure on companies to raise prices (link).
Additionally, remember that economies typically benefit from election-year spending by the political party in power.
2. Consumer spending dries up as savings decline: Consumers drive the economy, so if they actually close their wallets because they've exhausted their savings due to the Covid pandemic, it won't be good.
But this won't happen. First, workers trapped by the “humble” mentality of the pandemic are scattering once again. “The surge in labor force participation following the pandemic has led to an increase in total hours worked, supporting growth in disposable income,” says Michael Gapen, an economist at Bank of America.
After that, employment rates remain high in the United States, and unemployment claims remain low, notes Richard de Chazal, an economist at William Blair. Claims reached their lowest level in more than a year, for the week ending January 13. The bottom line here is that consumers tend to keep spending until they lose their jobs.
Other factors are also supporting consumer spending, says Ed Yardeni of Yardeni Research. He points out that baby boomers are retiring and spending their cumulative net worth of $75 trillion or passing it on to their heirs. Nearly 40% of homeowners in the United States do not have a mortgage, and most of the rest have been able to lock in mortgage rates to unprecedented levels.
Yardeni says his “misery index” (unemployment rate plus inflation) fell to 7.1% during December, well below its historical average of 9%. That's one reason why the University of Michigan Consumer Confidence Index rose in January to 78.8 from 69.4 in December.
3. Return of inflation: Like generals, stock market bears often make the mistake of fighting the last war. So, when we learned earlier this month that inflation in December rose, it supported the argument that inflation may not be so temporary after all.
But inflation will continue to fall. For one thing, history shows that this currency tends to fall as quickly as it rises, after it rises. There is also a lot of natural downward pressure on rising prices. China and Europe suffer from weak economies. Reduced demand from these regions puts downward pressure on oil and commodity prices. “China continues to export deflation to the United States and the rest of the world,” Yardeni says.
Zandi says rental vacancy rates are rising, and that is putting downward pressure on rent — the only inflation component that's holding back.
The hidden gift for equity investors in all of this is that lower inflation pushes cash yields lower. This has historically led to more money being sent into stocks than cash, notes Savita Subramanian, a strategist at Bank of America. Turning point: 5% returns on cash. Below that, people put more money into stocks. Money market funds have a record cash flow of $6 trillion. “Both institutional and individual investors hold high levels of cash,” she says.
4. Sentiment is too bullish, making the market vulnerable: When bullish investor sentiment gets too high, it makes the market vulnerable to pullbacks, in the opposite sense. I just don't see it. Consider this data from quantitative analysts at Bank of America.
Cash in mutual funds is one standard deviation above the mean. These are not elevated feelings. Hedge funds' exposure to discretionary stocks – a bullish bet – is near historic lows. Mutual funds' exposure to defensive consumer staples remains eight percentage points higher than at the start of 2022. Exposure to consumer discretionary is four percentage points lower. Private equity funds have a standard dry powder (cash). Households hold $18 trillion in cash, up from $13 trillion before the pandemic.
Sell-side strategists are similarly cautious. Bank of America tracks the sell-side index based on strategists' recommended portfolio allocation to stocks. This indicator is stuck in the neutral zone, in line with the 15-year average. Normally, after readings at this level, the S&P 500 SPX would rise 13.5% in the next 12 months. B of A concludes, “Fears of recession peaks have likely passed, but positioning still reflects more fear than greed.”
5. High oil prices due to the Middle East war: High oil prices hurt consumers through higher gasoline prices, and hurt corporate profits. I'm not smart enough to know whether conflict in the Middle East will shut down oil shipping lines, causing oil prices to rise. But if that happens, the disruption would have to last a long time to lead to a recession. Oil prices remained above $100 for six months after Russia invaded Ukraine in February 2022, and no recession followed.
Meanwhile, forces, including China's weak economy and record US production, continue to limit upward pressure on oil prices. Some analysts even wonder how long OPEC+ will remain united on production limits – given that Angola has just left the oil cartel.
Bottom line: Markets can correct at any time. But if I'm right that the bears are wrong, it makes sense to stay in stocks and overweight cyclical names in consumer picks, energy, materials and industrials, and discounted small-cap names that will do well as the market expands. It expands.
Michael Brash is a MarketWatch columnist. He publishes a stock newsletter called Brush Up on Stocks. Follow him on Xmbrushstocks
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