Earnings Growth, Fed Rate Cuts? What's in Store for U.S. Stocks in 2024?

Inflation, interest rates and recession fears drove the U.S. stock market in 2023, sending equity prices on a roller coaster ride. But after all the worries that the fastest pace of U.S. interest rate hikes in four decades would break the economy, two things continue to amaze: the strength of the consumers and the resilience of Corporate America. The S&P 500 gained 24.58% for 2023 as a whole through Dec.28, led by gains in NVIDIA, Meta, and etc.

If analysts' estimates for 2024 hold true, things could get even better for companies -- and that's fueling an optimistic outlook for the stock market. Investors found more reasons to hope for big gains next year after US Federal Reserve Jerome Powell's statement, signaling discussions on potential rate cuts are coming to the fore.

"You'd want to be reducing restriction on the economy well before 2%," Powell said after the Fed meeting on Dec. 13, referring to the central bank's core inflation target. That way, you don't overshoot, if we think of restrictive policy as weighing on economic activity," he said.

The latest government data show that the Fed's preferred measure of inflation, the personal consumption expenditure (PCE) price index excluding food and energy, was at 3.5% in November.

On Dec. 13, Fed officials pencilled in a total of 75 basis points in rate cuts next year as they decided to keep interest rates unchanged at a range of 5.25% and 5.5% until their next meeting.

Policymakers also don't see a recession next year, with the median of their projection showing a 1.4% growth in real gross domestic product. The most pessimistic outlook among the Fed officials was for a 0.8% growth next year.

Even days before the Fed projections on rate cuts were released, analysts were already expecting earnings growth of about 11.8% for companies in the S&P 500, according to FactSet. If estimates are proven right, that would exceed the 8.4% average growth seen in the decade 2012-2022.

After the December Fed meeting, Goldman Sachs Research raised its outlook for the S&P 500 to 5,100. That implies an 8% gain from the close on Dec.28. The investment joined Bank of America and OppenheimerAssetManagement in predicting that the index will climb to a record next year, according to Bloomberg. That's a more bullish outlook for Goldman, which just a month ago was expecting the gains to be concentrated in the second half of the year. That November forecast, which was upended by the Fed's rate cut projections, was based on the assumption that interest rates won't start coming down until the last quarter of next year.

On Dec. 14, MarketWatch reported that the company now forecast five quarter-point rate cuts in 2024 in light of Powell's dovish comments.

As of end of December, traders were already pricing in a 72.8% chance that the Fed will start cutting rates in March, according to the CME Fedwatch Tool. The odds doubled from 34.6% just a month earlier.

Investors will need to make deliberate choices in 2024, paying close attention to monetary policy if they want to avoid a variety of potential pitfalls and find opportunities in an imperfect world of cooling but still-too-high inflation and slowing global growth," Morgan Stanley analysts wrote in their annual outlook released Nov. 22.

They said global stocks typically begin to sell off in the three months leading into a new round of monetary easing, as risk assets start pricing in slower growth."We think near-term uncertainty will give way to a comeback in U.S. equities," Mike Wilson, chief U.S. equity strategist for Morgan Stanley, said in a research note. And Wilson expects earnings growth to remain robust into 2025: "Positive operating leverage and productivity growth from artificial intelligence should lead to margin expansion."

Healthcare companies could post the biggest 2024 earnings growth among the S&P 500's 11 sectors, with profit expanding by 19.1%, according to consensus analyst estimates compiled by FactSet as of Dec. 15. Pharmaceutical companies, which have taken a beating in 2023, are forecast to be the largest contributor in the sector, according to FactSet.

That's a rosy outlook given that healthcare was among sectors that sustained the heaviest hit just a few months back, with second-quarter earnings declining 6.2% from a year earlier, according to S&P Global Market Intelligence.

Energy companies saw an even bigger slump, with earnings shrinking by 48.8%, S&P data showed. Real estate companies recorded a 5.5% drop, while materials companies saw their profit fell 8.2%.

However, the earnings recession ended in the third quarter, with S&P 500 companies overall reporting 4.9% earnings growth -- the first expansion in a year, according to a FactSet report on Dec. 15.

JPMorgan Wealth Management said in its annual outlook posted on the company's website that "in 2024, equities offer the potential for meaningful gains. Even as economic growth slows amid higher rates, we think large-cap equity earnings growth should accelerate, and that could propel stock markets higher over the next year."

The firm said that stocks tend to do well when inflation ranges between 2% and 3%, with the S&P 500 posting an average year-over-year return of almost 14%. The latest government data show inflation was at 3.1% in November, while the personal consumption expenditure (PCE) price index, excluding food and energy, the Fed's preferred measure of inflation was at 3.5%.

In the case of Morgan Stanley, the firm's base case scenario is for S&P 500 to reach 4,500. Its bull case calls for the index to reach 5,050, according to a research note released in Nov. 22. Whether Powell's comments changed that view, we'll probably know in the next few weeks.

With many seen staying cautious in the first half of the year, Goldman said quality companies present a more compelling case for investment.

"Quality stocks — with higher profitability, stronger balance sheets, and stable sales and earnings growth —could outperform in an environment of persistent investor concern about an impending recession," Goldman analysts said.

Source: FactSet, Goldman Sachs Research, Morgan Stanley, JPMorgan, and Bloomberg