July 21, 2024

Stock Market’s 10 Surprises of 2024 and How to Invest: Bank of America

As soon as you think you know where the market is heading next, it will prove you wrong.

In 2023, the pros predicted that stocks would enjoy mediocre gains at best while the economy sank into a recession. Instead, we got a 24% rally, thanks in part to a resilient economy.

Now, in 2024, Wall Street is predicting the future again. But unlike most analysts attempting to anticipate the market’s every move, Bank of America’s Jared Woodard’s message to investors is simple: expect the unexpected.

In an homage to Byron Wien, the late investing legend who famously published annual lists of 10 surprises, Woodard, the head of Bank of America’s Research Investment Committee, outlined 10 “plausible surprises that could affect markets this year.” He also included what each scenario means for investors.

1. High bond taxes push investors back to stocks

One man’s trash is another man’s treasure, and the bond market was thoroughly trashed in 2023.

Bond prices tanked last year as the Federal Reserve hiked interest rates, sending bond yields higher — much higher — and investor inflows followed. According to Woodard, “the lure of yields above 5% for T-bills and bonds drew $3.7 trillion into Treasury securities in the first three quarters of ’23.”

But bond investments come with a hidden cost: taxes. Capital gains taxes for equities held longer than a year can be up to 20%. Some investors may be surprised to find that Treasury coupon payments are taxed differently: up to 37% for top earners, according to Woodard.

treasury bills bofa

Bank of America

How to invest: A large tax bill for bonds means more investors may turn their attention to stocks. It’s also good news for municipal bonds, some of which don’t require the bondholder to pay state or federal taxes.

2. Companies survive 5% rates without a surge in bankruptcies

It’s been a long and bumpy road, but the market might have seen the final rate hike in July 2023. Even after rates rose from nearly 0% in March 2022 to over 5% by last summer, the economy is humming — GDP rose an unexpected 4.9% year-over-year in Q3 2023 on the back of strong consumer spending.

Just as higher interest rates haven’t hurt consumers, they didn’t decimate businesses either. Woodard noted that corporate bankruptcies are near record lows, while interest expenses account for a mere 7% of corporate profits, their lowest level since 1957.

fewer bankruptcies bofa

Markets Insider

How to invest: “From a longer term view, termed-out corporate debt burdens, high cash & profit buffers, and $500bn in private credit dry powder make a big default and bankruptcy cycle seem unlikely,” Woodard wrote.

That’s good news for what Woodard called “Prudent Yield” assets, which include corporate bonds and senior loans for fallen angels — companies downgraded to junk — that might avoid bankruptcy after all.

3. IPOs come roaring back

With interest rates restricting startups and growth-focused companies from the sort of cheap financing they’d accessed for years, it’s no wonder that there was a dearth of companies going public in 2023. And the few that did hit the public market last year didn’t exactly wow investors, which only served to hold back any potential IPOs.

But Woodard thinks all that will change in 2024. If the Fed cuts rates this year as expected, then that could open the floodgates for private companies to go public.

IPO boom bofa

Bank of America

“In technology, venture capital funds are seeking exits after two unfriendly years; high-burn companies need cash and may see IPOs as preferable to raising capital at a lower valuation,” he wrote.

How to invest: The real beneficiaries, Woodard wrote, will be large banks and exchanges. Companies in these industries underwrite IPOs and stand to enjoy substantial profits from successful public offerings. He also noted that a surge in IPOs would be bullish for the SPDR S&P Bank ETF (KBE).

4. The worst developed market of the past 40 years is this year’s best

The market in question is, of course, Japan. Famously stagnant for the last four decades, Japan’s stock market had a remarkable run in 2023, with the benchmark Nikkei 225’s 28% gain outpacing the S&P 500.

Despite that rally, Woodard pointed out that Japanese equity valuations are still dramatically lower than their US counterparts, among other benefits the market offers.

“The Japanese economy is resilient, undervalued, and becoming more productive,” he wrote.

Bullish on Japan bofa

Markets Insider

How to invest: Besides the TOPIX, another Japanese stock market index like the Nikkei 225, Woodard noted that he’s broadly bullish on Japanese equities, which he suggested investing in via the Wisdomtree Japan Hedged Equity Fund (DXJ) or the Ishares MSCI Japan ETF (EWJ).

5. Suddenly, geopolitical risk is factored into the Magnificent Seven

The Magnificent Seven, the tech leaders of last year’s rally, have been seemingly impervious to geopolitical issues, growing in both market cap and in importance to the S&P 500. But Woodard thinks that’s over in 2024 as the market wakes up to the very real threat posed by the over-centralization of semiconductor manufacturing capabilities in Taiwan.

“According to CSIS, the ‘Magnificent Seven’ companies like Apple, Amazon, Google, and NVIDIA use Taiwanese manufacturers for over 90% of their chips,” he wrote. He later added: “Tensions continue to mount in the region and we suspect the risks will be priced into megacap growth stocks in 2024.”

Higher tech risk bofa

Bank of America

How to invest: While a re-evaluation of risks inherent in the biggest tech names on the market is bad news for the Magnificent Seven, Woodard believes it’s bullish news for equal-weighted equity indexes that don’t put as much emphasis on Big Tech as a market-cap weighted index. It’s also good for any baskets of investments that exclude tech stocks.

6. Biotech & pharma push to record highs

High hopes for healthcare were dashed by December of last year, as the sector turned in a middling performance for 2023 compared to the rest of the market. But Woodard noted that just means valuations look promising, particularly in the pharma and biotech sectors.

“If ’23 was the year of diabetes and obesity drugs, ’24 could be all about Alzheimer’s, with seven vaccines in trials and tests in progress on diabetes drugs as treatments for Alzheimer’s,” he wrote. “Drug discovery via molecular simulation remains one of the most plausible uses for artificial intelligence.”

Biotech bank of america

Bank of America

How to invest: Woodard noted that the Bank of America’s healthcare group’s favorite stocks in the sector are Eli Lilly and Merck. As for Woodard, he endorsed focusing on pharmaceutical stocks via the iShares U.S. Pharmaceuticals ETF (IHE).

7. Investors get pragmatic about energy

In theory, wind and solar power are viable options for alternative energy that can help the world cut back on fossil fuels. In practice, they are prohibitively expensive.

“Wind & solar stocks have been punished as project economics proved unworkable (Orsted -72% from peak; SolarEdge -77%; Sunrun -82%),” Woodard wrote. “On an all-in basis including storage & transmission, the average cost per megawatt-hour for natural gas is $38; nuclear $114; wind $291-504; for solar $413-1,548.”

A surge of interest in ESG investing over the last few years has died down as investors come to understand the costs behind clean energy. And while the US has made strides in adding clean energy sources to its power grid, Woodard thinks it’s not enough — particularly with the rapid addition of huge energy-consuming products like EVs and AI chips.

Alternative energy bofa

Bank of America

How to invest: “Investor pragmatism on a ‘physics > politics’ view of energy policy could mean multiple expansion and reward natural resource companies,” Woodard wrote. “Oil & gas stocks trade at just 10x earnings today; mining firms at 13x. Compare the S&P 500 and “clean energy” ETFs at 21-22x.”

That’s great news for companies in the oil, natural gas, and coal industries. And don’t forget about nuclear power, which has been in the spotlight of late as the spot price of uranium continues to soar.

8. One path to 2% inflation, one hundred paths to 5%

The market is primed for the Fed to pivot and begin cutting interest rates, perhaps even as soon as March. But don’t forget one of the Fed’s primary mandates: keep inflation under 2%.

Inflation is hovering around 3.4% — and Woodard warned that, despite investor optimism, there are plenty of disruptions that could send it higher this year rather than lower.

“The US-led coalition has been ineffective so far in stopping Houthi attacks on cargo ships in the Red Sea. 28% of world container trade passes through the Suez Canal,” Woodard warned. “Container prices have spiked 90% in recent weeks.”

There’s also higher gas prices, thanks to the war between Israel and Hamas, a conflict that has recently threatened to spill into Lebanon. These geopolitical conflicts, coupled with Black Sea grain deals that hang by a thread, as well as bad weather thanks to El Nino, could all contribute to rising food prices this year, Woodard wrote.

Woodard also pointed out that there’s rising federal employee wages to consider, thanks to a measure signed by the White House just before last Christmas, and a rising rate of housing starts over the last three months.

Finally, Woodard noted that the Fed’s favorite measures of inflation are still nowhere near its goal. “CPI core services less housing (the Fed’s “supercore” measure) remains at 3.9% and has been steady around that level since June 2023; still almost double the 2% Fed target,” he wrote.

Supply chain inflation BofA

Bank of America

9. Government debt buyers demand a premium

The US government has over $34 trillion in debt, and the interest payments on that debt will rise from just over $450 billion in 2022 to $1.4 trillion by 2033. As investors grow more alarmed by the mounting interest payments, Woodard believes they may want higher bond yields before they buy Treasurys.

“An economy slow enough to prompt Fed rate cuts may also be slow enough to depress tax receipts and raise unemployment payments, making the US budget deficit even worse,” Woodard wrote. “We find that, on average, federal tax receipts rise or fall by about 1.6x the change in GDP. A decline in nominal GDP from 6% to 3% would imply a drop of $230bn in receipts from 2023 levels.”

BofA higher interest rates

Markets Insider

How to invest: While he didn’t make any investment recommendations, Woodard noted that demand for higher yields is particularly bad news for US government bonds — especially in the coming months.

“The Treasury department has more than $5tn of securities maturing next year for which buyers will need to be found,” he warned.

10. Investors fall in love again with free markets

Over the last few years, Federal regulators have taken a particularly hard line. Regulatory bodies like the Justice Department and the FTC have stopped major mergers and acquisitions, while the SEC has clamped down on cryptocurrencies.

But in the course of duty, regulators have tamped down economic activity. “One study estimates that the cumulative costs of regulation has been 0.8ppt of GDP per year, and that if regulation had been held steady at 1980 levels, by 2012 the US economy would have been 25 percent larger (+$4 trillion),” Woodard wrote.

With presidential elections this November, however, Woodard noted that the door to less corporate oversight might be opened — which would translate to an improved bottom line for companies across the market.

“As the US election approaches, prospects for a friendlier business environment could raise investor expectations for higher profits and productivity, stoking animal spirits and prompting a greater allocation to equities.”

BofA regulatory activity

Bank of America

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