High inflation, record setting increases in interest rates, war in the Middle East and in the Ukraine, and a breakthrough in artificial intelligence marked some of the major developments that happened in 2023. From an investment point of view, In 2023, the S&P500 was driven by seven stocks labelled the "Magnificent Seven": Microsoft, Meta, Alphabet, Apple, Amazon, Nvidia and Tesla. The other 493 barely contributed to the S&P500 overall return. Will this flip in 2024? Let's take a closer look.

 

In 2023, interest rates increased at a record-setting pace. In 2024, at a minimum, interest rates will pause (and most likely come down) during the year. Most economists are predicting at least three rate cuts by the Federal Reserve in 2024.

 

Why is this important? When interest rates are going up, the market anticipates higher costs for companies that have high debt ratios. If you're wondering why the Magnificent Seven did so well last year and everything else did poorly, it's because (for the most part) the magnificent seven companies have no debt. Additionally, most of the seven were heavily invested in artificial intelligence. Take a look at the chart below – from a debt-to-EBITA (Earnings Before Interest, Taxes, and Amortization) ratio perspective, indices with high debt ratios did not do nearly as well as indices with low debt ratios, like the NASDAQ. The Russell 2000 (R2K) index has the highest debt ratio on the chart, and its poor performance last year corresponded with this as expected. If a company has a lot of debt and interest rates go up, the cost to service that debt also goes up and takes away from their earnings.

 

Source; Bloomberg, BMO GAM, as of November 8, 2023. EBITDA: Earnings before interest, taxes, depreciation, and amortization

 

If we are assuming that interest rates will be going down in 2024, then it should be fair to assume that high-debt-ratio companies would benefit from the decreasing interest rates. Most value-oriented companies tend to have a lot of debt, for example: utilities, pipelines, banks, and REITs. In one of my previous notes, I also talked about why value-oriented companies go up when interest rates go down (because their dividends become more valuable on a % per share basis). With these two factors in mind, we believe that the market breadth will get bigger and companies other than the "Magnificent Seven" will participate and contribute significantly to the returns in 2024.

 

One other thing that should be pointed out is that 2024 is a US presidential election year. Since 1952, the S&P has not declined in any election year in which the incumbent president was running for reelection. If you believe that history repeats itself, this bodes well for 2024.

 

I've also included a piece from our CIBC Economics team entitled "Monthly World Markets Report”.

 

As always, if you have any questions, please feel free to give us a call at any time.

 

Have a great weekend.

 

Milan