The S&P 500 index secured its fifth consecutive weekly gain by the close on Friday, reaching a new high for the year and a level not seen since March 2022. This propelled the index to a 19.7% gain in 2023, closing at 4,595, fueled by optimism surrounding the potential for the Federal Reserve to implement rate cuts in early 2024 due to easing inflation. While we anticipate further stock gains in 2024, driven by a sustained rebound in corporate earnings, the recent market activity suggests a potential moderation in the size of future US stock gains.
In Monday's trade, the S&P 500 experienced a slight dip of around 0.5%, settling near 4,570. This adjustment can be attributed to the rise in US Treasury yields and a reassessment of expectations regarding Fed rate cuts. Despite the robust November rally, our outlook suggests more restrained potential for US stock gains ahead, projecting the S&P to conclude next year around 4,700.
The recent boost from falling yields is expected to ease, though stocks still present a relatively more appealing option compared to government bonds. The 10-year US Treasury yield, which hit a 16-year high of 5% in October, has receded to 4.25% as of December 4, with further declines expected to 3.5% by the end of 2024. However, the descent may not be smooth, as markets might have factored in an excessively optimistic outlook on monetary policy, implying a greater than 55% chance of a first-rate cut at the Fed's March meeting.
While earnings growth is poised to bolster stocks in 2024, the potential for increased stock valuations is limited in some markets. Our base case predicts a 9% rise in earnings per share for S&P 500 companies next year. However, measures of stock valuations, including the 12-month forward price-to-earnings ratio, indicate limited room for expansion in numerous equity markets.
The MSCI All Country World Index trades at 16 times 12-month forward P/E, approximately 10% above its 15-year average. Emerging markets, our favored equity region, stand out as an exception, with valuations at their 10-year average and maintaining an above-average discount to their developed market counterparts. This gap, in our assessment, does not account for the superior earnings growth prospects in emerging markets next year relative to global peers.
Amidst an uncertain growth and geopolitical outlook, the path for stocks may encounter volatility. The macroeconomic and geopolitical uncertainties elevate the unpredictability around our earnings estimates, potentially leading to pockets of equity market turbulence in the coming year. Consequently, we advocate focusing on high-quality stocks from companies exhibiting strong returns on invested capital, resilient operating margins, and relatively low debt.
Our neutral stance on equities in the global strategy underscores the most potential residing in quality stocks, with specific value identified within US tech, stable quality-income, and high-quality cyclical stocks in Europe, as well as select names in Asia.
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