In January, most economists have been convinced that cussed inflation and rising rates of interest would result in an imminent recession, and Wall Avenue’s high minds have been feeling bearish about 2023.
However Fundstrat International Advisors co-founder Tom Lee was optimistic. The veteran market watcher, who beforehand served as JPMorgan’s chief fairness strategist, argued that the S&P 500 was set to soar practically 25% to between 4,750 and 4,800 by year-end.
It was an out-of-consensus name, on condition that forecasters surveyed by Bloomberg had a median year-end goal of simply over 4,000 for the blue chip index. However Lee believed that the Fed’s rate of interest hikes would be capable of tame inflation with out sparking a job-killing recession—the vaunted financial “soft landing” that, traditionally, has been hard to come by.
Now, that decision is wanting fairly prescient. The labor market has proved its resilience this 12 months; inflation has steadily dropped from its 2022 four-decade excessive; and the financial system continues to develop. Because of this, the S&P 500 is up over 23% year-to-date, just some share factors away from Lee’s year-end goal.
After this monumental rise in shares, which noticed the Dow Jones Industrial Common hit a record high this week, some traders are starting to surprise if there are any positive aspects left available.
“The recent rally in the market has investors pricing in the perfect soft landing for the economy, without the pain of a recession,“ David Donabedian, chief investment officer of CIBC Private Wealth US, said Friday. “This may not be realistic, however.”
Donabedian warned that even when it’s “all systems go” for markets within the close to time period, there are “lingering concerns about valuations and ultimately a scenario that may be too rosy.”
Lee, ever the bull, disagrees. And he has a recommendation for traders: look to smaller firms for outperformance subsequent 12 months.
“In the next twelve months it seems like small caps can be up 50%,” he told CNBC Friday, arguing the Russell 2000 index, which tracks U.S. shares with a mean market capitalization of simply $2.8 billion, might rise from 1,996 to three,000 by year-end.
How small cap shares might outperform in 2024
Subsequent 12 months shall be all about fading inflation and rate of interest cuts, in keeping with Lee, and that ought to profit the small-cap shares which were hit the toughest by rising borrowing prices. Small caps are inclined to have increased leverage, which suggests the Fed’s interest-rate hikes over the previous 18 months have dramatically affected their backside line.
Because of this, the Russell 2000 is up simply over 14% this 12 months, in comparison with the S&P 500’s roughly 23% rise. But when inflation continues to fade in 2024, main the Fed to chop rates of interest as is now broadly forecast, that may very well be a boon for small caps. And Lee is satisfied inflation has already been tamed.
“I think inflation is easily going to hit the 2% core target sometime next year, and sort of stay there,” he stated.
He famous that customers’ inflation expectations, an excellent predictor of precise inflation, are falling. People’ one-year inflation outlook sank to simply 3.1% within the College of Michigan’s December client sentiment survey launched final week, a marked drop from the 4.5% in November and the bottom stage since early 2021.
Lee additionally argued that 60% of core inflation—a metric that excludes extra unstable meals and power costs—comes from housing, automobiles, and automobile companies, classes which can be now not seeing enormous value jumps.
“Housing and cars alone account for 1.74 percentage points of the excess inflation. We’re at 1.6% of excess [inflation]. So literally those two things account for all the inflation,” he famous.
To his level, U.S. residence costs rose simply 4.7% year-over-year in November, whereas lease costs fell 2.1% from a 12 months in the past, in keeping with Redfin data. New automobile costs have additionally fallen for 3 consecutive months, in keeping with Cox Automotive. And used automobile costs dropped 5.8% from a 12 months in the past in November, in keeping with the Manheim Used Vehicle Value Index.
So long as housing inflation “stabilizes” at 6% and automobile costs proceed to fall, Lee believes inflation will drop to the Fed’s 2% goal and “stay there” in 2024.
For traders, this implies small caps that can profit most from rate of interest cuts current alternative, particularly given how low-cost they’re in comparison with bigger friends. Lee famous that small-cap shares are a very good purchase relative to the worth of the property on their stability sheets, referred to as guide worth.
“On a price to book basis, [small caps] are trading at where they were in 1999, relative to the S&P. And that was the start of a 12 year outperformance cycle,” Lee stated.
