This morning, the equity futures are indicating selling when trading kicks off stateside, with the Dow and NASDAQ futures both down more than 175 points at one point. The day will be very light on both earnings and economic news, so stock market participants will be looking elsewhere. Reports that Iran has sent a warship to the Red Sea, threatening a key shipping route, have heightened geopolitical concerns and renewed oil supply worries. The price of crude both here and overseas rose this morning on the report.
The new year kicks off with the major equity indexes looking to build on a nine-week winning streak that ended 2023. The recent bull run has been fueled by the retreat in Treasury market yields during the final two months of last year and emerging sentiment that the Federal Reserve will at some point pivot on the monetary policy front in 2024. We still think the direction of trading in the first week of the new year will likely depend upon a slew of data from the labor market, including Friday’s upcoming report on December employment and unemployment. Before we get to that potential market-moving release, we will receive reports on manufacturing activity and the Job Opening and Labor Turnover Survey (JOLTS) tomorrow and initial weekly unemployment claims and private-sector job creation from Automatic Data Processing on Thursday.
A tight labor market and solid job creation figures over the final months of 2023, along with data showing a retreat in inflation powered the equity markets higher. The late-year surge pushed the Dow Jones Industrial Average, the broader S&P 500 Index, and the technology heavy NASDAQ Composite 13.7%, 24.0%, and 43.4% higher for the 12-month period. A good portion of those gains came from strong showings from the “Magnificent Seven” mega-cap technology stocks. In addition though, there was a notable late-year increased appetite for riskier holdings among investors. The drop in Treasury market yields and the expectation of lower interest rates in 2024 helped the interest-rate sensitive small cap stocks, which for a good part of last year lagged their larger-cap brethren. For the full year, the biggest winners were the technology, communication services, and consumer discretionary sectors.
The late-year buying pushed equity valuations notably higher. The CBOE Volatility Index (or VIX), also known as the “fear gauge” ended 2023 at 12.45, a level that clearly suggests that the market is overbought. This elevated valuation leaves stocks vulnerable to selling on any unfavorable news, much as we are seeing this morning with the reports of mounting tensions in the Red Sea. It will also put a lot of focus on the upcoming fourth-quarter earnings season. We think a good showing from Corporate America will be needed to justify the current elevated stock valuations. The expectation is that earnings growth slowed to the low-single-digit range in the fourth quarter. The season kicks off on January 12th when banking giant JPMorgan Chase (JPM) leads a slew of big banks to report. The commentary from those big banks may also give some clues about the health of the U.S. economy at the start of 2024.
With valuations for stocks looking quite frothy right now, we think the best way to play this market rally, which is being powered by falling Treasury market yields and the expectation that the Federal Reserve will begin cutting interest rates at some point in 2024, is by looking at the stocks of high-quality companies. Wall Street will like to see earnings growth from the companies to justify valuations, so those that have a history of generating steady earnings and cash flows even during difficult economic conditions may hold some extra appeal. These stocks, which are typically ranked 1 (Highest) and 2 (Above Average) for Safety by Value Line, have less downside risk in our opinion if the upcoming earnings season fails to impress Wall Street. – William G. Ferguson
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.
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