Barclays Outlook for US Stocks: Year-end "sprint" has exhausted the gains, next year's increase will be in single digits.

The optimistic sentiment of continued cooling inflation and dovish remarks from Federal Reserve officials are driving the US stock market to start the year-end rally. Wall Street is confident about the "Christmas market" and is increasingly bullish on the S&P 500's performance next year.

Amid the optimism of major investment banks on Wall Street, Barclays' forecast is slightly cautious. On November 28th, Barclays' team led by stock strategist Venu Krishna released a report raising the target price for the S&P 500 index in 2024 by 300 points to 4800 points.

This means that there is still a 5% upside potential for US stocks next year from yesterday's closing price. Krishna pointed out in the report that the return rate of US stocks next year will be in single digits, reflecting a gradual slowdown in economic growth despite easing inflation.

The report states that based on an optimistic outlook for corporate earnings prospects, the expected earnings per share for the S&P 500 index next year has been raised from $223 to $233. However, even with the adjusted expectations, it is still $13 lower than the market consensus.

The report believes that the market consensus for double-digit earnings growth per share in 2024 is overly optimistic, as continued inflation resistance, weak industrial output, and slowing growth outside the United States will put pressure on the US stock market.

Krishna warned in the report about the continued rise of the US stock market at the end of 2023. If the stock market "goes too far, too fast" at the end of 2023, it will prematurely exhaust the upside potential for 2024, resulting in a smaller increase next year.

In terms of sector selection, the Barclays team prefers large-cap technology stocks and non-essential consumer goods sectors. They believe that large-cap stocks will outperform small-cap stocks and place more emphasis on value and quality factors rather than growth.

Barclays: Market is overly optimistic about fiscal year 2024

Barclays points out that although their expectations for the macro outlook in 2024 are more optimistic compared to the past few months, economic activity is still likely to slow down, making the market's expectations for accelerated earnings growth per share unrealistic:

We expect the earnings per share of the S&P 500 index in 2024 to be $233, higher than our previous forecast of $223, but still below the consensus value of $246.

While an economic recession in the United States in 2024 is not our base assumption, we still expect economic growth to slow down and eventually experience a quarter of negative growth, putting downward pressure on the S&P 500.

Barclays points out in the report that although they have raised their expectations for consumer spending since the mid-year outlook, their current view on consumption is still below consensus expectations: Previously, we assumed that commodity consumption in 2024 would still be below trend levels. As we enter 2024, consumer conditions have improved, and it is expected that commodity consumption will return to average levels in 2024, with negligible negative impact on the profitability of the technology industry.

However, deflation, weak industrial production, and a global macroeconomic slowdown will put pressure on the profitability growth of companies outside the technology industry.

Barclays believes that there has been a change in the profit trend of companies in the third quarter of 2023, but it is too early to determine whether this change is sustainable:

We previously believed that negative operating leverage would continue to constrain corporate profits, mainly due to deflation, gradually weakening pricing power, and inventory destocking costs. However, in the third quarter of 2023 financial reports, we found that there has been a change in the profit trend of companies, so we have reforecasted the trend of the US stock market in 2024.

The year-on-year revenue growth rate of the S&P 500 component stocks began to slow down in the third quarter of 2022, which roughly coincided with the peak of inflation.

As inflation slows down, companies' pricing power weakens, leading to a slowdown in nominal sales growth. Due to the slowdown in sales growth and relatively strong costs, companies have experienced operating leverage effects and have faced profit pressures for six consecutive quarters. However, it seems that we have reached a turning point in the third quarter.

Barclays points out that from the optimistic expectations of Wall Street for 2024, the inflection point of profit margin that started in the third quarter of this year is sustainable. With the support of a significant increase in profit margin, earnings per share of the S&P 500 will achieve strong growth in the fourth quarter of 2024:

However, we believe that the performance and estimate revisions of some companies have significantly influenced the trend of overall operating leverage, which may mean that the performance of a small number of companies in the entire industry or market has affected the overall trend of operating leverage.

By analyzing the inflection points of profits in different sectors in the third quarter of 2023, we found that in the technology and non-essential consumer goods sectors, sales growth exceeded cost growth. These sectors, with high weights in the index, are driving the improvement of the profit margin of the S&P 500 index, while the remaining sectors still face significant profit pressures.

The S&P 500 has moderate upside potential

Barclays believes that after evaluating the valuation and price of the S&P 500, there is moderate upside potential in 2024. At the same time, although the valuation of technology stocks exceeds that of other companies in the S&P 500, there is still optimism about the upside potential of technology stocks:

Our valuation of the technology industry is based on next twelve months price-to-earnings (NTM PE multiples), and for the parts of the S&P 500 index outside the technology industry, we apply a valuation framework based on macro factors, considering interest rates, inflation, and the Purchasing Managers' Index (PMI) for the manufacturing sector. We have observed that the valuation of the technology industry has fallen from its recent peak and is still far below the post-pandemic peak. Although the price-to-earnings ratio of technology stocks once exceeded 37 times during the initial rebound of the pandemic, the valuation has since adjusted, and the current trading P/E ratio is below 29 times.

Although the valuation of technology stocks is still relatively high compared to other industries in the S&P 500 index, we believe that considering the range of P/E ratios after the pandemic and the optimistic sentiment regarding profit growth and future revenue guidance in the technology industry, there is still potential for moderate upward movement from the current level.

We estimate that the trading prices of S&P 500 index constituents, excluding technology stocks, are very close to fair value, with only a 1x premium. However, there is still downside risk to the fair value of non-technology stocks, mainly due to higher interest rates and a slowdown in the Purchasing Managers' Index (PMI) for the manufacturing industry.

Be cautious of the "rush" risk at the end of 2023

Barclays pointed out that the triple negative factors of weak October employment report, unexpectedly dovish stance of the Federal Reserve, and declining Treasury yields have triggered strong technical buying in stocks, forcing many investors to return to the U.S. stock market. However, the year-end rally will squeeze the upside potential of U.S. stocks next year:

"For stock investors, the market situation for U.S. stocks in 2023 is like riding a roller coaster. From the current situation, global macro hedge funds still hold a considerable number of short positions in stocks, which may be forced to close due to market rallies. The influx of institutional funds may maintain the short-term seasonal strength of U.S. stocks, and this year's year-end rally has already borrowed from next year's increase in U.S. stocks, squeezing the upside potential for next year."

J.P. Morgan's Data Asset and Alpha team stated that the signals from hedge funds regarding their positions for the remaining time in 2023 are "mixed", showing an extremely complex "mixed signal". The accelerating trend of deleveraging may indicate that the market is approaching its peak. In addition, although the crowding alpha value of hedge funds has weakened, it has not shown significant pressure:

"The pace of hedge funds' closing of long and short positions is accelerating, which often occurs when the market rebounds to its peak, supporting the view that the recent rebound trend has ended."

J.P. Morgan predicts that the stock market will face downside risks next year. They point out that the stock market is currently "overvalued," especially considering the weakening business cycle, restrictive monetary policy, and geopolitical risks. Volatility is close to historical lows. At the same time, future profit growth is "lackluster," with projected earnings growth of 2% to 3% for the S&P 500 index in 2024. Therefore, Goldman Sachs has set a target price of 4200 for the S&P 500 index, representing a decrease of nearly 8% from the previous day's closing price of 4550.