The stock market's performance in 2023 has been so strong that the S&P 500 has rallied nearly 20%, a large gain that many on Wall Street are labeling a new bull market.
The rally likely surprised most, given that the stock market’s double-digit tumble in 2022 was the worst since the Great Recession in 2008.
One person who wasn't surprised, however, was Wall Street analyst Tom Lee. Last December, he was among the few who broke from the crowd, calling for stocks to rally significantly in 2023.
We haven't quite reached Lee's 4,750 target, but given this year's performance, I doubt many are complaining.
Recently, Lee updated his outlook, highlighting what could happen to the S&P 500 in 2024. Given Lee's prescient prediction this year, investors should pay attention to what he's saying now.
TheStreet / NYSE / Tom Lee
Stocks climb a wall of worry in 2023
The Federal Reserve's battle with inflation hasn't been won yet, and despite progress, consumers are still paying more for goods and services than they were one year ago, hamstringing budgets and crimping economic growth.
The sharp increase in the Federal Funds Rate to 5.25% has kept many investors on the sidelines this year because of worry that higher rates would push us into a recession. So far, that hasn't happened, but that doesn't mean that the U.S. economy is humming along.
Related: Analyst who forecast Amazon's stock drop last month has a new price target
The Federal Reserve said in September that gross domestic product, or GDP, growth would be just 2% this year. The manufacturing sector has been contracting for most of 2023, according to the ISM Purchasing Managers Index (PMI), and the services PMI has been trending lower since late 2021.
One bright spot remains unemployment, which is still historically low at 3.7%. However, cracks are emerging there, too. Unemployment was 3.4% in April, and the number of open jobs has slipped to 8.7 million from 10.5 million one year ago, according to the Bureau of Labor Statistics.
Corporate earnings haven't instilled confidence, either. The S&P 500's earnings per share declined year-over-year for three consecutive quarters until the recently reported third-quarter results put it back in the black, with growth of 4.7%.
Given this backdrop, it's little wonder why investors have been apprehensive. Tom Lee says $240 billion has flowed out of stocks for safer pastures this year.
Yet, despite all of those headwinds, stocks have marched higher. Sure, the summer swoon was particularly nerve-racking to investors. But given we're up 20% in 2023, many who swapped stocks for other investments are likely scratching their heads, wondering if they made a mistake.
Will the S&P 500 go up in 2024?
The million-dollar question on everyone's mind is if 2023's rally can continue into 2024. While many of the risks facing the market remain, and a recession isn't yet off the table, Lee's latest forecast is encouraging.
On Real Money Pro, Lee laid the groundwork for why investors may not want to be bearish. Much like in 2023, Lee points toward the progress that's being made in wrestling inflation lower, from a peak above 9% in June 2022 to about 3% now.
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According to Lee, moderate increases in prices for goods and services will continue next year, underpinning the stock market. Further, while many cite the S&P 500's valuation as a reason to worry, Lee isn't convinced that a high price-to-earnings (P/E) ratio alone is a problem.
"We see P/E expanding in 2024 towards 20X," writes Lee. "While many argue for valuation compression, since 1937, the highest P/E is realized when yields are 3.5% to 5.5%. When between 4% to 5%, P/E is >18X 65% of the instances."
The 10-year Treasury yield is currently 4.25%, down from 5% in October. That's helping ease mortgage rates, which peaked above 8% earlier this quarter, but are now about 7%.
If Lee is correct, then a higher valuation could propel stocks because he also expects earnings per share (EPS) to be greater next year.
"We see 2024/2025 EPS growth of 11.3%/8.3% to $240/$260 driven by cyclical EPS recovery," says Lee.
The possibility that lower inflation allows rates to fall, boosting valuations even as profit improves leads Lee to conclude that stocks could move meaningfully higher.
"We expect equities to surprise consensus to the upside in 2024, delivering +12% to +15% returns," writes Lee. "Our 2024 [year end] target is 5,200 which is 20x 2025 EPS of $260."
That's a pretty bullish outlook, but Lee doesn't think that those returns will happen evenly throughout the year. Instead, he expects the second half of the year to be better than the first half.
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