Decline or not? As the year ends, Wall St. is divided on what lies ahead.

Twelve months ago, Tom Lee bet that 2023 would go just fine.

While many of his colleagues on Wall Street were sounding the alarm about an impending economic downturn, Mr Lee, a stock market strategist who led JP Morgan’s equity research for more than a decade before founding his own firm, predicted in December 2022 that the decline would be inflation and economic resilience could break the generally bearish mood.

Mr. Lee was right. Despite political mismanagement over the country’s debt ceiling, a banking crisis in March, fears over the cost of financing the government’s budget deficit, an ongoing war in Ukraine and a new conflict in Israel, the core of Lee’s prediction came true in 2023 . Inflation is down, unemployment remains low and the S&P 500 is up 24 percent.

Most investors disagreed with Mr. Lee’s forecast; in 2023, they raised more than $70 billion from funds that buy U.S. stocks, according to data from EPFR Global. According to Morningstar Direct, only a quarter of fund managers whose performance has been benchmarked against the S&P 500 have beaten the index’s return this year.

“2023 was a year where people were so convinced we were going to have a recession and they looked at everything through that lens,” said Mr Lee, head of research at Fundstrat. “Then there were people like us who said we don’t know the future, but there is little evidence that a recession is coming.”

Heading into 2024, forecasters tracked by Bloomberg share Lee’s optimism more broadly, including analysts at Citigroup and Goldman Sachs. Binky Chadha, an equity strategist at Deutsche Bank who bet against the consensus with Mr Lee last year, also predicts the bull rally will continue.

At the same time, analysts from Morgan Stanley, JP Morgan and others argue that the absence of a severe downturn in 2023 does not mean it has been avoided altogether, as the full effect of higher interest rates is still rippling through the economy.

“There are a lot of things that have to go right for us to still come out unscathed,” said Mike Wilson, chief equity strategist at Morgan Stanley. He revised his bearish bets in July, although even then he did not budge from his position that the economy would deteriorate.

Central to both views is the trajectory of inflation and whether the Federal Reserve can reduce the pace of price increases to its 2 percent target before the economy sputters.

The Fed began slowing the economy in March 2022 by raising interest rates. But the central bank has recently shown confidence that it is getting close to its target. The consumer price index rose 3.1 percent over the year to November, down from a peak of more than 9 percent through June 2022. The core CPI, which excludes volatile food and energy prices, remains at 4 percent.

The sooner the Fed achieves its goal, the sooner it can take the foot off the brakes on the economy. The central bank recently predicted lower interest rates for next year. Even without interest rate cuts, falling inflation and historically high wage growth could encourage consumers to keep spending, boosting corporate profits even further, Lee said.

Others are less confident. While the labor market remains strong, recent months have shown early signs of weakness, with a modest increase in unemployment as more people look for work. Credit card delinquencies and the number of people who are delinquent on car loan payments are also rising as investors note the strain on consumer finances following the withdrawal of student loan debt forgiveness plans . With inflation still above the Fed’s target, these cracks could widen in the coming year.

Jason Hunter, equity strategist at JP Morgan, said the market appears to be ignoring an expected slowdown in growth next year. “It appears the stock market is priced for a very rosy outcome,” he said.

While the services side of the economy, such as restaurants, has held up well this year, manufacturing has struggled after a period of overproduction in 2022.

Energy stocks remain negative this year after being the star performers in 2022. Utilities – usually a haven when other parts of the market are in turmoil, thanks to their steady revenue stream – are down more than 10 percent since January. Smaller companies have also withered away; the Russell 2000 index is still about 20 percent below its previous peak and 16 percent higher for the year.

For Mr Lee and the growing herd of market bulls, these unloved parts of the market offer opportunity in 2024. A reversal of the production decline, with companies clearing the backlog of inventories and placing new orders, could help struggling companies catch up in 2023 .

Deutsche Bank’s Mr. Chadha noted that economists have consistently underestimated the size of the economy’s growth this year. He thinks it will probably happen again.

“We think we will have positive growth surprises that will drive stock prices higher,” he said.

Those who are more bearish say a recovery in industrial production is far from assured and that the decline in those sectors of the market in 2023 could be a warning sign that if not for a few giant tech stocks that lifted the S&P 500 had lifted, the S&P 500 The stock rally would look very different.

These tech stocks have been so dominant that they’ve even earned themselves the nickname the Magnificent Seven. It’s a group that includes some of the largest companies on the market: Apple, Microsoft, Alphabet, Amazon, Nvidia, Meta and Tesla. Without them, the S&P 500 would have risen almost 60 percent.

“If average companies don’t see improvement, to me that’s the risk of a hard landing,” said Morgan Stanley’s Mr. Wilson. “If we have a recession, that will be when these companies decide to let people go.”

For Mr Lee, history points to a different outcome. When the S&P 500 has risen at least 15 percent, which happened 28 times through 1950, the index is up another 10 percent the next year half of the time and is positive 70 percent of the time, he says. And when rates were previously between 3 and 5 percent, the stock market’s valuation has been similar to what it is today, suggesting the rally is not overdone.

“People try to be too theoretical about the stock market,” Mr. Lee said. “Accepting chaos is a more correct way to approach the market.”