Get Your Portfolio Ready for 2024

Publisher’s Note: The S&P is negative over the past two years while readers of Foundational Profits are up 40% in the same time. I’ve included part of the December issue below to help you get your portfolio ready for 2024. It includes my outlook for stocks, interest rates, the economy and inflation. And if you’d like to see how my portfolio is positioned heading into the new year, you can get the full issue here. 

— Nick

Get Your Portfolio Ready for 2024

The S&P 500 remains lower than it was two years ago. 

Put another way, the thing that most people mean when they say “the market,” has delivered no return over the last 700 days.

Meanwhile, following the guidance of this letter would have you up some 40% in that same time. 

Going strictly by the calendar, the S&P has had what anyone would agree is a great year. It’s up 20.15% as the winter solstice approaches. 

But that of course is not the entire picture and the market cycle remains more complicated than “stock market is up for the year so the bear market / recession worry is over.”

And while the northern hemisphere will soon start tilting back toward the sun, I don’t believe the same is in store for the stock market as we head into a new calendar year. 

Here are themes and indicators that help explain that conclusion and justify our positioning, some of which I have touched on in previous letters. (Click here to get our full list of positions and allocations.)

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1. Weighting & The Giants

The S&P 500, like most major stock indexes, is a capitalization-weighted index. 

That means instead of all 500 components being weighted equally at 0.2% to make 100% they are instead weighted based on their individual market capitalization relative to that of all 500 companies. 

Example: Microsoft has a $2.8 trillion market cap. The market cap of all 500 S&P components is $38.45 trillion. So Microsoft is 7.3% of the index. 

What’s happened is the giants have gotten so large that they now influence a disproportionate amount of the index, making it not a great reflection of actual overall stock market performance. 

At the end of November, the top ten biggest companies in the index were weighted at 31.6%. And even within the top ten there is disproportion with Microsoft weighted 5.5x more than UnitedHealth Group.

Index Top Holdings

Returns, of course, are returns. And so I’m not knocking anyone who bought the S&P 500 on January 3 this year and is up 20.15%. 

What I’m saying is that, literally all things being equal, the S&P 500 has delivered average annual performance. 

Two takeaways from this: 

First, I view this primarily as a symptom of market mechanics being out of whack. We talked in February about the rise of short-dated options and also about the need for liquidity. This concentration in big names is part of that. Buying record amounts of near-term calls on an already-weighted average is like a magnifying glass to a sunbeam. Simultaneously, seeking out the biggest companies on the US exchanges as a store of liquidity during bank collapses amid the worst bond market ever has made them even bigger stores of liquidity. How that ends remains to be seen. 

Second, and as already stated, returns are returns. Buying the S&P 500 this calendar year would have made you money despite the overall cycle still being negative. That said, if you knew this concentration was going to emerge, which few if any did given that at the start of November long-only hedge funds were up on average 2% for the year, you would have just bought the mega-caps and called it a day. Indeed, a fund of the 50 largest S&P 500 components far outperformed both the weighted and non-weighted index as we see in this chart comparing the S&P 500 (SPX) to the Invesco S&P 500 Top 50 ETF (XLG) and the Invesco S&P 500 Equal Weight ETF (RSP).

Largest S&P Components Outperform

2. Yield Curve Still Inverted

The US10-year yield minus the US02-year yield has been a negative number, meaning the curve has been continuously inverted, since July 2022. It is saying a recession is still coming as it is in no danger of going positive.

US10Y - US02Y

3. Since 2007...

If history rhymes but doesn’t repeat, Biggie Smalls is currently on the macro mic. 

The US 10-Year bond yield just touched 5% for the first time since 2007. In October, the 30-Year yield hit its highest since 2007.

There have been nine straight downward revisions in monthly non-farm payrolls, which hasn’t happened since 2008. 

Consumer bankruptcies and foreclosures were up 19% year over year in Q3, the fastest pace since the global financial crisis. 

4. Manufacturing... Recession

The Institute for Supply Management’s (ISM) manufacturing purchasing managers index (PMI) was at 46.7 for November, marking the 13th consecutive month of contraction. 

That is the longest such stretch since the Dotcom-crash era. A Reuters article titled “US manufacturing mired in weakness, economy heading for slowdown” that came out on the heels of that report noted:

U.S. manufacturing remained subdued in November, with factory employment declining further as hiring slowed and layoffs increased, more evidence that the economy was losing momentum after robust growth last quarter.

Indeed, as noted in last month’s issue: 

The US economy showed growth in Q3 driven mostly by government spending. The seasonally adjusted annual rate came out at 4.9% for the quarter. That growth will now slow significantly. The consensus estimate for Q4 GDP is 0.8%. And it’s lower than that for Q1 and Q2 2024 at 0.3% and 0.6%, respectively. That next-to-nothing growth could easily be negative growth. So queue up the revival of recession talk for the New Year.

This is also why you’ve had talk of coming rate cuts that allowed the stock market to rally in November similar to what it did in July. Yet it is still failing to break out of its two-year malaise in any meaningful way. 

S&P 500 Fails to Break Out to New Highs

And it’s why you’ve had talk of both disinflation (or deflation) alongside inflation, as also noted in last month’s issue. 

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So, cutting to the fruitcake: 

Stock Market: I am still seeing no reason to allocate to the broader stock market in any larger way than we already are. 

Economy: I see a slowing of the economy over the next two to three quarters to next-to-nothing to negative growth. Real economic expansion north of 4% doesn’t return until the second half of 2024. Oil is confirming this contraction, now down 23% from its recent peak at $95 per barrel in late September.

Oil Price (US$: barrel)

Inflation: Remains sticky high near 3.5% for two to four quarters to come. That’s up to a year of well above-Fed-target inflation.

Rates: Economic growth isn’t going to contract fast or crashy enough that the Fed cuts rates any earlier than mid-year. Even more so because inflation is going to remain sticky high. If the Fed does cut rates sooner than later, it means the recession that materializes is much harsher than anyone’s now calling for.

Still, the rate-hiking cycle as I see it is over. 

Click here to get the rest of the issue, including new stock recommendations. 

Call it like you see it,

Nick Hodge

Nick Hodge
Publisher, Daily Profit Cycle