At the beginning of every year, market pundits make predictions about where the S&P 500 and the TSX indices will end up based on how they see the economy and corporate earnings developing. And then a surprise (or ten) comes along. That is just the reality of financial markets.

To illustrate, let’s look at just a handful of events that surprised investors in 2023.

1. U.S. Regional Banking Crisis… and Recovery – Few people predicted that the rise in bond yields would set off a series of events that would lead to two U.S. regional banks to collapse in March. The S&P 500 tumbled 5% in a week. But just as surprising was how quickly markets stabilized despite worry that other banks could be next. The fear created a buying opportunity.

2. Artificial Intelligence Boom – The emergence of Chat GPT in late 2022 allowed us to see how accessible artificial intelligence (AI) could be to the broader public. But the biggest corporate surprise of the year came in May when Nvidia said that its third quarter revenue would be $4 billion higher than analysts expected thanks to surging demand for its computer chips critical to the AI revolution. Its stock, which had already more than doubled over the prior six months, soared an additional 25%, adding a stunning $184 billion of market value in one day. At the beginning of the year the company was expected to generate $4 per share in earnings in the year ending January 2024. Analysts now expect that figure to be greater than $12.

3. Impact of GLP-1s – Some people were predicting the growing popularity of Ozempic and other GLP-1 diabetes and obesity drugs before 2023 began. But the surprise came when the shares of companies such as Coca-Cola, Pepsi, and Kraft Heinz endured a five-month mid-year slide on fears that these drugs would impact global demand for soft drinks, snacks and other packaged foods. Shares of medical device companies such as Medtronic and Smith & Nephew also fell as investors assumed that obesity reduction would result in less need for knee and hip replacements. Walmart seemed to confirm these fears in early October when management said customers that bought Ozempic in its pharmacies were buying less food. That warning, however, marked the peak of the fear, and the stocks bounced in the final months of the year. Investors seemed to realize that any such broad impact would occur at a slower and more modest pace than was being priced into the stocks.

                          Source: FactSet, RBC Wealth Management

4. Year-end Rally – Outside of the large-cap tech stocks, most stocks were little-changed by late October due to steadily-rising interest rates. Once bond yields peaked, however, it did not take much to light a fire under stocks. The S&P 500 soared more than 15% in the final two months of the year as the odds of a recession diminished while the U.S. central bank signaled that interest-rate cuts were coming in 2024. Such a strong market response was surprising given the last time stocks rallied that much over a 10-week period was following the December 2020 announcements from Pfizer and Moderna that they had effective Covid-19 vaccines.

Current Expectations

So the unexpected happened last year, as it has every year, and will likely occur this year as well. That does not mean that one should not set some expectations and position one’s portfolio accordingly. It just means that one should not place outsized bets on such forecasts and that one needs to monitor conditions and be willing to make adjustments as new information presents itself.

For now, here are some of our base-case expectations for the new year:

      A) A broader market rally: Some may look at the 24% gain on the S&P 500 and its 19.8x price-to-earnings ratio (P/E) and feel that it would be hard to add to those gains. However, those gains were concentrated amongst the “Magnificent Seven” large cap technology stocks (Alphabet, Amazon, Apple, Meta Platforms, Microsoft, Nvidia and Tesla) which have an average P/E of 32x. The typical stock in the U.S. benchmark index gained only about 12% last year. (It is worth remembering that the S&P 500 fell 19% the previous year, so much of last year’s gain was merely a recovery.) We believe that if the U.S. economy remains resilient while inflation continues to cool, the stocks that lagged last year will be able to outperform.

      B) Elevated sentiment and the presidential elections will add some volatility: While we believe stock indices will be higher by the end of the year, the opening weeks and the middle months could provide some bumps along the way. After the 15% rally on the S&P 500 in the final two months of 2023, there is some excessive bullishness to start this year. The last two times investors were this bullish (early 2018 and mid-2021), returns over the subsequent 12 months were weak. We have already seen stocks ease to start off 2024, but some further cooling may be needed to reset some expectations. A U.S. presidential election year also tends to trigger some mid-year turbulence and we see no reason to expect anything different this time around given the state of politics south of the border.

                          Source: American Association of Individual Investors Survey, RBC Wealth Management

One of the key issues we will continue to monitor throughout the year will be whether the slowing European and Chinese economies will pull growth down in the rest of the world, which could hurt corporate profits. Canada also has some vulnerabilities given its slowing housing market.

So we have some thoughts as to how the year might play out, with some uncertainties in particular areas that we are monitoring (the latter of which may be called “known unknowns”.) But we are also aware that there will undoubtedly be some unexpected developments that will come out of left field (the “unknown unknowns”). During any volatility caused by such unforeseen events, it is important to remain level-headed and not to overreact. How have we been able to do that in the past? With the knowledge that we have well-constructed and diversified portfolios while maintaining a balanced view on the near and long term. Here’s to whatever surprises 2024 may bring.

If you have any questions, please do not hesitate to Contact us!