According to the American Institute of Individual Investors (AAII), investors were the most
pessimistic in the last twelve months almost one year ago when the weekly index of pessimism about
the future reached 52.3%. It is 19.6% now. This is the lowest reading on pessimism since 2018.
According to the survey, investors optimistic about the future of the stock market sands at 48.8%, far
above the historic average of 37.5%.

A year ago the Standard and Poors index was careening towards a calendar return of minus
18.1% No doubt this influenced both the survey and the forecast for 2023. While this year is not over
as this is written, it appears that S & P returns will be in the neighborhood of 19 percent. Just as last
year’s slide prompted a number of dark forecasts for 2023, the high return of this year (which is
actually a recovery from last year’s decline), creates optimism going forward.

It is generally known among market forecasters that predicting an extension of the existing
trend is an easy way to gain credibility. This is because the forecast supposedly has reality as a
backdrop. If the market is going up, it is clear skies. After all, if this were not the case, why would the
market be going up? Conversely, if the market is going down, one must approach the future with a
foreboding. If there were no problems, why is the market going down?

A good investment manager is supposed to get out in front of trends, not follow them. The
problem with following trends is the issue of deciding when they reserve. If one decides too soon, there
is a cost in getting back on the trend. If one decides too late, capital is lost.

In fact, the AAII survey is something of a contrarian indicator. When the investing public is
optimistic it is time to be careful. When the investing public is pessimistic it is time to be aggressive.
Warren Buffet summed this strategy in his saying, “Be fearful when others are greedy, and greedy
when others are fearful.” Given the propensity of crowd behavior this is not the easiest thing to do. It
is the most rewarding over time.

The next year already comes with Great Expectations for investors. Interest rates are supposed
to fall, causing bonds to appreciate. Stocks are supposed to book impressive earnings which are to be
translated into higher prices. Inflation is predicted to continue to decline to the magical two percent per
year, which is supposed to give the Federal Reserve license to cut interest rates. Events beyond our
borders will remain so. The dollar will continue to be strong. The 2024 elections will go off without a

The problem with Great Expectations is that they do not always go according to plan. Falling
interest rates are more the prediction of bond traders who would profit from the same. Whatever
economic growth ensues will be padded by inflation. There is no credible forecast at this time that
inflation will hit two percent and stay there in 2024. International events are a wild card that can go
either way. Domestic events the more so.

If all of this puts macro forecasting in the realm of reading tarot cards, you are getting warm. It
is relatively easier to analyze a company than it is to forecast an economy. That does not keep people
from trying to do it, but to base investment decisions on the state of data at one point in the year is to
obviate the input of data at other times. As John Maynard Keynes once said when he was criticized for
changing his investment position, “When the facts change, I change my opinion. What do you do sir?”

Perhaps more instructive than the data is certain trends in investing. The issue of concentration
has been addressed previously. Seven stocks make up 29 percent of the value of the S & P index. These
seven stocks have gone up collectively 72 percent this year to date. The remaining 493 stocks are up
only 8 percent, with about 40 percent showing losses for the year. While a number of reasons have
been given for the divide, the bottom line is that it is not healthy. Index funds have been a culprit here.
Should investors abandon them for other approaches, look out below.

For all the rally of this year, the indexes at this writing are still below their all-time highs. For
the S&P 500, that high was set January 3, 2022. The Dow Jones Averages peaked January 4, 2022, and
the NASDAQ November 19, 2021. Certain stocks have done better. Many have done worse.

However, one does not invest in the past. The investment issue is how to invest in the future. It
is relatively easier to analyze a specific company, making assumptions about that stock’s environment,
than the fate of a packaged financial product like a mutual fund or ETF. Unlike the physical sciences,
the relationship between investments and outcomes varies with time. Also investing, by definition, is
dealing with incomplete information. Wait for all the information and the opportunity is lost. The
evaluation of information and whether it is already reflected in the investment’s price is the true worth
of investment management. Not everyone is capable of it.

The Economy

Economic activity shows some signs of slowing as the year ends. The third quarter had
economic growth in excess of 5 percent. A slowing of this pace is inevitable in an economy of the size
and maturity of the US.

Going into the new year, there is positive momentum in health care, construction, and defense.
There is some slowdown in labor force growth. The forecast now is for 1.6% growth in 2024 versus
2.4% after-inflation growth in 2023.

Interest Rates

Interest rates are generally expected to decline in 2024. The timing and extent of the decline is
in dispute. Monetary authorities keep saying that interest rates will not be reduced until inflation
moderates below 2 percent. Traders in the bond market are betting the Fed is bluffing, and that interest
rates will decline sooner rather than later.

One overlooked angle to interest rates is the value of the dollar. If interest rates decline, the
ability of the US to attract foreign investment is curtailed. Such a move by foreigners would send
interest rates back up, as lower foreign investment inflows would require that domestic parties buy the
new and retiring government debt being generated. It would also portend a recession as higher saving
leads to lower consumption. The ideal solution is to lower the budget deficit and be less dependent on
foreign funds to finance the US government. That does not appear to be in the cards.


Wage gains appear to be accelerating. This is concerning, as wage inflation becomes very
difficult to dislodge once it becomes a public expectation.

While optimists keep looking for inflation to decline to 2 percent per year, trends do not favor
such a development. Wages, foreign competition for raw materials, and the like all conspire to keep
inflation above the 2 percent level.

The Stock Market

After two years, we are back where we are at the beginning of 2022 in terms of overall stock
prices. This is not to say that all stocks have declined and recovered, but that the overall indexes have
done as much. In the same vein, not all stocks will do equally well going forward.

One thing that impedes stocks are their high valuations. In some way stock values are higher
than they were in 1999 or 2008, before their last declines.

Interest rates will provide serious competition for equities in general. Companies that have
reasonable valuations and specific situations should do better.

Stocks that have high valuations are called in the trade “story stocks”. The problem with story
stocks is that the story seldom turns out well.

Warren M. Barnett, CFA
December 8, 2023
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