Mapping the progression of the FT Wilshire 5000 index last year we can see that it was not a smooth ride. In Q1 confidence dipped (plot 01) on bank contagion fears following the collapse of SVB bank. Risk appetite then recovered following a focus on AI and the Mag 7 stocks (plot 02). The Fed poured water on interest rate optimism with a ‘higher for longer’ narrative which impacted investor confidence in Q3 (plot 03). Finally, confidence that peak rates had been achieved with optimism over the commencement of the easing cycle in 2024 generated the second major up-leg in Q4 (plot 04).
Exhibit 1: Key inflection points in the FT Wilshire 5000 in 2023.
Without the contribution of PE expansion last year US equities would have returned just +10.5%
In Exhibit 2 below we deconstruct 2023’s market returns into the contribution from 3 components – the element attributable to EPS forecast increases (red), the growth of dividends (blue) and valuation shift (grey). US returns were heavily skewed to the contribution of PE expansion. Without this component the US would have returned c.10%. This would have brought US returns more in line with World ex US returns which did not benefit from as large a PE expansion kicker in 2023. We also show that the Mag 7 stocks constituted almost 50% to the aggregate US PE expansion.
Exhibit 2: Deconstructing US and World ex US return drivers
2024 needs a new driver – time for EPS growth to take up the baton
While 2023 delivered spectacular US equity returns, this was despite witnessing sequential downgrading of EPS growth forecasts. The table below shows that last January the consensus expectation was that the US and World ex US would deliver +7.1% and +14.2% EPS growth respectively. These forecasts experienced successive downgrading with latest estimates for 2023 at +1.9% for the US and -0.5% for the World ex US.
However, forecasts point to a strong recovery in EPS growth (around +13% for both regions) this year. If 2024 does not see a repeat of the 2023 salami slicing of forecasts, then EPS growth could well become the key driver of risk appetite. This would also help broaden the profile of market returns.
Exhibit 3: Regional consensus EPS growth rate forecasts
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Source: Wilshire Indexes, LSEG Datastream, FactSet . Data as of January 19, 2024.
