While earnings growth should support stocks in 2024, the potential for rising stock valuations is more limited in some markets. (UBS)

CIO expects stocks to gain further in 2024, pushed higher by a continued rebound in corporate earnings.


But after such a strong rally, the potential size of US stock gains looks more modest—we forecast the S&P will end next year at around 4,700.


The recent tailwind from falling yields will likely moderate. The relative appeal of stocks has improved compared to government bonds, with the yield on the 10-year US Treasury falling from a 16-year high of 5% in October to 4.22% as of 4 December. We expect the yield to fall further to 3.5% by the end of 2024. However, the decline is unlikely to be smooth, in our view. Investors may now be pricing in too much good news on monetary policy, with markets implying a more-than-55% chance of a first rate cut at the Fed’s March meeting, with five 25-basis-point reductions over the year. Our base case is that the Fed will deliver two to three cuts next year and most likely starting in July.


While earnings growth should support stocks in 2024, the potential for rising stock valuations is more limited in some markets. Our base case is for a 9% rise in earnings per share for S&P 500 companies next year, after a flat outcome for profits in 2023. We think that leaner inventories, one-off base effects in healthcare, and earnings contributions from the technology sector and other quality companies should offset headwinds from slower US economic growth. But we believe that measures of stock valuations, including the 12-month forward price earnings ratio, leave little room for further expansion in many equity markets.


The MSCI All Country World Index is trading at 16 times 12-month forward price-to-earnings (P/E), around 10% above its 15-year average. Only in emerging markets—our most preferred equity region in our global strategy—do we see scope for rising multiples. Valuations for the MSCI Emerging Markets index are at their 10-year average, and still stand at an above-average discount to their developed market peers. In our view, the gap does not factor in better earnings growth prospects for emerging markets next year (16% growth by our estimates) relative to global peers, including the Eurozone (where we forecast 3% growth).


An uncertain growth and geopolitical outlook suggests the path for stocks could be choppy. Uncertainty around the broader macroeconomic and geopolitical outlook creates higher uncertainty around our earnings estimates. This may lead to pockets of equity market volatility in the year ahead. As such, we think investors should consider focusing on high-quality stocks from companies with strong returns on invested capital, resilient operating margins, and relatively low debt on their balance sheets. A proxy for these stocks, the MSCI ACWI Quality Index, has historically outperformed the MSCI ACWI by 1 percentage point over six-month periods in which growth has been slowing but staying positive (as measured by the Atlanta Fed GDPNow survey)—the environment we expect in 2024.


So, investors’ pleasure that US stocks have reached year-to-date highs may be tempered by more limited potential in many major stock market indexes for the coming year. We hold a neutral stance on equities in our global strategy—and identify most potential in quality stocks. We see particular value within US tech; stable quality-income and high quality cyclical stocks in Europe; and in select names in Asia.


For more details on these ideas and more, click here for our Year Ahead 2024: A new world.


Main contributors - Solita Marcelli, Mark Haefele, Christopher Swann, Jon Gordon, Jennifer Stahmer, Matthew Carter


Read the original report : Look for quality as US stocks hit 2023 high, 4 December 2023.