- Stocks defied Wall Street's gloomy predictions this year.
- Equities' surprise rally should teach investors two key lessons heading into 2024, according to UBS.
That's UBS's main takeaway from 2023, where stocks defied Wall Street's gloomy predictions about rising interest rates and a US recession to charge higher. The S&P 500 has jumped 20% over the past 11-and-a-half months, while the Nasdaq Composite has soared 39% over the same period.
In a research note published this week, the Swiss bank shared two key lessons that investors should learn from the surprise rally – both of which could carry on driving returns next year.
Lesson #1: 'Race to the bottom'
While both US inflation and growth may head downward, which of them will lead the "race to the bottom" will be decisive in shaping investor sentiment, if this year's trends are any guide, according to UBS strategists.
"The sequencing of economic developments mattered a great deal for market performance [in 2023]," strategists wrote in Tuesday's research note.
In 2023, inflation declined well before the Federal Reserve's interest-rate hikes could dent economic growth — and that played a key role in delivering a more upbeat outcome for financial markets. Should a similar dynamic play out in 2024, markets could benefit from that, according to UBS.
"While we expected growth to slow early in 2023 and were thus cautious on US risk assets at the start of the year, if inflation could credibly race growth to the bottom, a better market regime could emerge in 2023 after a difficult 2022. That's exactly what happened and then some," the strategists wrote.
In January, inflation was still lingering at 6.5% – way clear of the Federal Reserve's 2% target – and much of Wall Street was fretting that the central bank's aggressive interest-rate hikes would drive a spike in unemployment and drag the US economy into a recession.
But inflation has dropped to just 3.1% as of November and in one of 2023's surprise developments, growth has held strong, with the US's gross domestic product expanding at the fastest pace in two years over the third quarter.
"The data for at least the next month could continue to exhibit that ideal combination of ongoing disinflation and resilient growth for markets to keep rallying," they added, likely referring to Tuesday's Consumer Price Index print and Thursday's initial jobless claims data.
Lesson #2: Data is king
Reeling from the "everything bubble" rally morphing into a dismal sell-off, this year the market has zeroed in once again on cold, hard economic data.
Red-hot jobs reports from the first half of 2023 fueled a third-quarter slump with traders fretting the Fed might have more scope to keep hiking, while more recent inflation prints have sparked an end-of-year rally.
UBS's second main lesson for investors is that seemingly minor datapoints could keep fueling major fluctuations in stock prices, with the market still uncertain if the economy will dodge a recession.
"When the macroeconomic environment is highly uncertain and investor conviction on what's going on in the economy is low, it only takes a few data points to prompt sizable swings in expectations for a recession compared with a soft landing," strategists said.
"A couple of weak labor market reports in the first quarter of 2024 would challenge the consensus faith in a soft landing," they added.
Stocks may have a so-so 2024
Both those takeaways back up UBS's view that stocks are headed nowhere fast next year, the strategists said.
The Swiss bank is predicting that the benchmark S&P 500 will end 2024 at 4,700 points – implying just a 1% gain from its current level.
"It is too optimistic to expect immaculate disinflation to continue without frequent market inflections, in our view," UBS said in Tuesday's research note. "Markets are likely to remain range-bound, even if the range for equities has shifted higher."
In other words, the same factors that have fueled this year's surprise rally will carry on dictating stock prices – but investors shouldn't count on returns being anywhere near as spectacular.