Stocks have picked up right where they left off last year, with new highs across the board and the S&P 500 officially closing above 5,000 for the first time. Although on the surface there isn’t much of a difference between 5,000 and 4,999, it’s an important psychological milestone for investors. One year ago, investors were being bombarded by talk of the bear market and an imminent recession. But now we have a healthy economy, well-contained inflation, a Federal Reserve set to cut rates, improving productivity, record earnings, and stocks at all-time highs. What a ride it has been, but investors were once again rewarded for sticking to their investment plans.
- The S&P 500 closed above 5,000 on Friday for the first time in history.
- Over the last 15 weeks, stocks have gained more than 22%, marking one of the best 15-week periods ever.
- A pullback would be perfectly normal at any time, but overall the bull market is alive and well.
- The potential for further productivity gains after a strong 2023 continues to be an important focus for us at Carson.
- Productivity gains help create a virtuous cycle in which real wages grow without adding pressure to inflation, helping to keep interest rates low, which in turn spurs further investment.
- Business investment would need to increase to make further productivity gains sustainable.
So, what now? At Carson, we remain overweight equities and expect this bull market to continue. But stocks have truly had a rally for the ages, so a well-deserved break or consolidation could happen at any time. A downturn would be perfectly normal, but higher prices remain likely to follow.
The chart below lists previous major S&P 500 milestones and the returns that followed. The good news is the S&P 500 was higher six months later every time and up a solid 8.0% on average, versus the average six-month return of 4.4%.
What a Run
The S&P 500 has finished higher 14 of the last 15 weeks, something it hasn’t done since early 1972. Over those 15 weeks it gained 22%. In its entire history, the S&P 500 has never been higher 14 out of 15 weeks and gained more than 20% over that time. If you’ve been invested these last 15 weeks, it is safe to say you’ve been enjoying a historic stretch for the bull market.
After a 20%-or-better rally over 15 weeks, would you believe the market tends to see stronger longer-term returns moving forward? That’s right, this type of strength isn’t typical of the end of a bull market or the middle of a bear market. Instead, it’s more typical of the start to a longer-term bullish move.
We found 14 other times the S&P 500 gained 20% or more in 15 weeks. One year later the index had added another 12.5% on average and was higher 85.7% of the time.
In sum, stocks are quite overbought and some type of weakness at any time shouldn’t come as a surprise. But the underpinnings of this bull market are alive and well, with higher prices likely over the next 12 months.
There Are Reasons to Be Optimistic About Productivity
Productivity growth surged at an annual rate of 3.9% over the last three quarters of 2023, which is the largest non-recessionary gain since the late 1990s and more than double the pace of productivity growth between 2005 and 2019.
As we wrote in our 2024 Outlook, “Seeing Eye to Eye” (download here), productivity growth is a game-changer for the economy. Higher productivity means workers can have strong income gains without putting upward pressure on inflation. This in turn allows the Federal Reserve to back off from running interest rates at a very high level. Easier rates and the promise of higher demand, thanks to stronger incomes, can spur business investment — into labor, technological equipment, and structures — all of which can further boost productivity. That’s the virtuous productivity cycle, pictured below, which we last experienced in the late 1990s.
The economy may be poised for a further resurgence in productivity, at least above the low levels experienced over the last decade and a half.
A Strong Labor Market Is Key
A lot of hiring took place in 2021 and 2022, with the economy more than recovering all the jobs lost in 2020. However, newly hired workers are not immediately productive — businesses must invest in training them. Also, businesses have an incentive to invest more when labor markets are tight. If a worker can get higher pay by switching jobs, which is what happened in 2021-2022, employers may have to pony up more to keep them. At the time, it looked like productivity was falling. However, all this investment in labor bore fruit in 2023, and productivity started to surge.
Hiring eased in 2023, but it was more normalization than a slowdown. The economy still created more than 3 million jobs in 2023. As we wrote a week ago after the January payroll report was released, most indicators suggest the labor market is as strong as it was back in 2019. Wage growth is running above the pre-pandemic pace. Despite this, annual inflation fell from 5.4% at the end of 2022 to 2.6% at the end of 2023 (using the Fed’s preferred measure, the Personal Consumption Expenditures Price Index). Strong wage growth did not lead to upward pressure on inflation, fundamentally, because of productivity growth, amid supply chain improvements. Consumption ran above trend in 2023, but a more productive workforce was able to produce more goods and services to keep inflation at bay.
All these developments are why the Fed was able to stop hiking rates by July 2023 and is now potentially considering rate cuts. This leads us to the factors that could drive productivity gains.
Artificial Intelligence (AI) Is Not a Big Driver, but It’s Early Days Yet
Generative artificial intelligence (AI) and its prospects to boost productivity have drawn a lot of attention. The reality is we haven’t seen the impact of AI yet on a broad economic level. After adjusting for inflation, investment in information processing equipment is running below the 2017-2019 trend. It did pick up in the fourth quarter, but clearly we have some ways to go.
The productivity surge in the late 1990s came on the back of a boom in business investment and, notably, investment in computer equipment. As Preston Mui, an economist at Employ America, points out, investment in computer equipment made a significant contribution to GDP growth between 1995 and 1999 (side note: I highly recommend Employ America’s series on productivity, “The Dream of the 90s”). Investment in software is calculated as part of “intellectual property products investment” within GDP, and even this played a big role, as shown in this chart from Employ America.
Recently, productivity growth has surged without much contribution from AI. But over the next several years, AI could be a significant driver. Companies are increasingly investing in AI, and it’s going to take time for that investment to lead to increased productivity.
It’s important for investment to rise above the recent trend line, and that will get a boost if the Federal Reserve pulls back on its aggressive interest rate stance. We believe the Fed will start that process in a few months, especially as inflation continues to ease. Lower inflation combined with income growth propelled by a relatively strong labor market will keep consumption (and the economy) humming. That’s another key factor that will push businesses to invest. By contrast, if companies believe economic growth will ease to the relatively low levels of the last decade, there will be less incentive to invest.
Encouragingly, the latest earnings season shows forward expectations of capital expenditures (capex) for companies in the S&P 500 continuing to push higher. Over the six years from 2014 to 2019, forward capex rose 22%. Since the end of 2021, through January 2024 (two years and one month), forward capex has grown 21%.
We believe the economy may have turned the page on the last decade of lackluster economic growth and low productivity, which is also why we’re overweight equities in our strategic Carson House View portfolios and overweight U.S. equities in particular. As we wrote in our 2024 Outlook, right now the significance of AI for productivity is not so much about its immediate impact on economic growth, but rather the forces in place that create and foster AI. AI itself is a strategic play that can support the long-term growth of corporate profits. But in the near term, it’s about continued innovation that investment makes possible.
This newsletter was written and produced by CWM, LLC. Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. The views stated in this letter are not necessarily the opinion of any other named entity and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.
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