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Why Did Stocks Drop to Start 2024?

January 08, 2024

Markets started 2024 with a relative “thud” as the S&P 500 fell 1% while widely held tech names traded even worse, with the Nasdaq falling more than 3% last week. But the reason for the declines wasn’t so much because something bad happened but instead just because the first data points of 2024 didn’t validate aggressive (and possibly unrealistic) expectations for 2024.

We must acknowledge that the S&P 500 rallied more than 11% in the Q4, but virtually all of that rally came from late October through December. An 11% gain in a year is a big return, never mind in essentially two months, so it’s reasonable we’d have “give back” at the start of the year, and we have. But there are reasons stocks declined last week other than just being short-term overbought.

First, inflation data bounced back, and while no one is doubting disinflation, in the context of the market entering 2024 with a 100% probability of a March rate cut, that buoyant inflation data pushed back on that assumption.

Second, growth data was “ok” but not good enough to validate the market’s full belief in a “no landing” economic scenario. So, while the growth data wasn’t bad, it didn’t meet the current market assumptions.

Put simply, last Tuesday I identified the five market assumptions for 2024, because whether stocks rally or decline will be determined by how the data measures up to those assumptions. Last week, it didn’t measure up well, so stocks dropped. But importantly, none of the data was that bad either. It just wasn’t good enough for the S&P 500 to be valued at 19.5X next year’s earnings.

To that point, if more data this week (including CPI) doesn’t meet the dual market expectations of 1) A March rate cut and 2) Continued aggressive disinflation, expect a further pullback in the S&P 500, potentially to 4,600 or lower. Even if that happens, the outlook for markets will still remain positive over the medium term.

As things sit now, any pullback towards 4,500-4,600 should be viewed as an opportunity to add exposure, if you’re looking to do so, because the fundamental outlook for stocks remains positive given: 1) Solid economic growth, 2) A newly dovish Fed and 3) Falling inflation. The problem for the market as we start 2024 is that positive outlook isn’t quite good enough to justify a 19.5X multiple but remember the markets tend to expand beyond what appears reasonable.


Bottom line: In the near term, this market has an expectation problem as it has priced in rate cuts in March and Immaculate Disinflation (falling inflation and stable growth). If the data doesn’t match that expectation (which it didn’t last week), stocks will drop. But just because the outlook isn’t perfect, it doesn’t mean it still isn’t good and that’s the needed context to view last week’s declines and any continued pullback through the first weeks of the year.

To better explain that point to regular investors, I used this analogy to describe the current market dynamic with a friend at a birthday party this weekend: It’s like you’re taking your family to Hawaii for vacation and because the kids flew first class once, they now expect it all the time. So, there’s some disappointment when they find out they’re in coach, but they’re still going on a great vacation!

From a tactical standpoint, given my concern about a growth scare in the markets in the coming months, I have 1/3 in value stocks because of the lofty expectations. I still believe that all will depend on the earnings reports that start this Friday.

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