Despite the stock market rebound, falling inflation and a strong labor market in 2023, investors will have to contend with plenty of headwinds and volatility in 2024, including the Federal Reserve keeping interest rates higher for longer…a potential contraction in consumer spending, which could lead to economic recession…and the prospects of a highly contentious US Presidential election.

Bottom Line Personal asked top fund picker Janet M. Brown to identify the most prominent trends likely to affect the stock market next year and which no-load stock funds and exchange-traded funds (ETFs) are best positioned to find opportunities and protect your portfolio…

Key Trends

Japan could continue to lead markets overseas. Even Warren Buffett is cheering the world’s third-largest economy, which has stagnated for decades. The Nikkei 225 Stock Average hit its highest level in 2023 but remains historically undervalued. The Japanese government’s longtime efforts to strengthen the economy and stanch deflation appear to finally be working, and Japanese corporations are returning more of their profits to shareholders. Efforts to broaden global supply chains beyond China are sparking new foreign investment in Japan.

High-quality US growth stocks may dominate. Slower economic growth, moderating inflation and secular growth tailwinds such as artificial intelligence could propel high-quality growth stocks. Stocks of these large-cap companies, which have solid balance sheets and business models that profit in good and bad times, have outperformed the S&P 500 in 2023 through October 30.

Alternative investments could stabilize portfolio volatility better than bonds. Adding bonds to a stock portfolio has been a popular way for investors to curb volatility, but bonds are still stuck in a bear market due to rising yields that depress their prices. Funds that use hedging strategies, such as shorting (betting against) stocks and investing in currency and commodity plays, may offer more consistent performance with low correlation to the stock and bond markets.

US cash cows are likely to surge. A good way to find undervalued stocks in the coming year is to look for companies with strong free cash flow—the cash remaining after a company has paid its expenses, interest and taxes. Reason: High interest rates make it very expensive for companies to borrow money. Those with plenty of spare cash may be better positioned to withstand turbulent economic times. It also gives them the flexibility to reinvest spare cash in dividends, share buybacks or the long-term growth of their own businesses.

International value stocks could outperform growth counterparts. Bargain-priced stocks in developed foreign economies surged 17.21% over the past year versus just 9.51% for pricier, fast-growing stocks. Reason: Undervalued companies, which often make consumer staples such as food and household consumables, could benefit from elevated interest rates and better-than-expected economic growth. They may be better positioned to pass along higher prices to customers. The MSCI EAFE Value Index has a price-to-­earnings ratio of just 10 versus 23 for the MSCI EAFE Growth Index.

For Aggressive Investors

If you can tolerate ups and downs, funds that invest in narrow niches could be strong prospects for gains. Consider putting up to 5% of your stock portfolio in these types of funds, including…

Wisdom Tree Japan Hedged Equity ETF (DXJ) tracks more than 400 stocks on the Tokyo Stock Exchange that focus on dividend payouts, export revenues and other factors rather than the companies’ sizes. The portfolio is dominated by dividend-paying industrials such as ­Toyota Motor Corp. and Mitsubishi Corp., but it keeps about 25% of its assets in mid- and small-cap stocks. This passively managed fund also eliminates a major risk for small investors by mitigating currency swings between the Japanese yen and the US dollar. In 2023, the yen fell over 12% through October 30 against the greenback because short-term interest rates in the US soared while the Bank of Japan maintained a near-zero rate to stimulate growth. Recent yield: 2.35%. Performance: 38.84% (one year) and 10.3% (10 years).*

For Moderately Aggressive Investors

If you can handle moderate volatility, similar to that of the S&P 500 index, and have enough time to wait out drops in stock prices, you can use these funds as core holdings in your portfolio…

Causeway International Value Fund (CIVVX) seeks out-of-favor or misunderstood foreign stocks in developed nations. The companies are undervalued due to temporary challenges and rough patches such as earnings shortfalls and changes in leadership. Manager Sarah Ketterer has run this venerable fund for more than 20 years. She holds a portfolio of roughly 60 holdings, including Rolls-Royce Holdings, Samsung Electronics and the major Italian bank UniCredit. The fund, which holds mostly industrial and financial-service stocks, is a nice diversifier for tech-heavy US portfolios. Performance: 25.01% (one year) and 2.95% (10 years).

Fidelity Contrafund (FCNTX). Will Danoff, former assistant to legendary investor Peter Lynch, has managed this fund to market-beating returns since 1990 through different economic cycles. Over the past decade, it has topped the S&P 500 index by one percentage point a year. How he does it: He looks for large, best-of-breed companies with competitive advantages that can double earnings over five years. He likes fast-growing companies still led by their founders because studies show they are more innovative and incentivized to grow. Although the fund has a massive asset base of about $106 billion, it is spread over more than 300 holdings including Meta Platforms, Berkshire Hathaway and UnitedHealth Group. Performance: 21.98% (one year) and 11.85% (10 years).

Invesco S&P 500 Quality ETF (SPHQ) ranks all the constituents of the S&P 500 using factors such as debt, ­balance-sheet metrics and return on equity, which gauges a company’s profitability and how efficiently it generates those profits. This passively managed fund then picks the highest-ranking 100 and weights the highest-quality stocks more heavily. Top holdings include Adobe and MasterCard, and only four stocks in the fund’s top 10 holdings match that of the market-cap–weighted S&P 500 index. Result: A collection of profitable, high-quality industry leaders with solid fundamentals that tend to hold up better in economic downturns. The fund lost about two percentage points less than the S&P 500 in the 2022 bear market and has beaten it over the past 10 years. Performance: 14.16% (one year) and 11.32% (10 years).

Pacer US Cash Cows 100 ETF (COWZ) provides an effective way to find bargain-priced large- and mid-cap stocks. This passively managed fund screens the Russell 1000 for the 100 companies with the highest “free cash flow yield,” which is free cash flow relative to the market capitalization of the company. The resulting portfolio is weighted by free cash flow yield and rebalanced quarterly, with each holding capped at a 2% maximum to ensure diversification. Energy and health care make up 50% of the portfolio with top holdings such as McKesson Corp. and Chevron. Performance: 4.18% (one year) and 12.92% (since 2016 inception).

For Conservative Investors

For years, risk-averse investors turned to balanced funds—a mix of stocks and bonds—to buffer their portfolios’ ups and downs. But now there are actively managed funds that use risk-­management strategies popularized by hedge funds. They can offer fixed-income–like returns over time and help diversify a portfolio by not moving in sync with stocks or bonds. Note: High turnover rates mean these funds may not be tax-efficient and are better suited for tax-deferred accounts…

Guggenheim Multi-Hedge Strategies Fund (RYMSX) holds about 400 investments and provides exposure to a variety of alternative strategies such as shorting stocks, currency investing and merger arbitrage, which allows investors to profit from corporate takeovers and mergers. This fund’s eclectic mix is meant to mute the impact of macroeconomic and market fluctuations. During the 2022 bear market, it lost just 3%. Performance: 2.08% (one year) and 2.51% (10 years).

Vanguard Market Neutral Fund (VMNFX). I recommended this fund for 2023. It proved its mettle, rising 13% over the past year. It aims to profit modestly even in flat and declining markets by utilizing computer models to ­create a “long-short” strategy. How it works: The fund invests about half its assets in reasonably priced stocks with consistent earnings. With the other half, it shorts stocks that it expects to fall. The portfolio, which has more than 450 holdings, has been 50% less volatile than the S&P 500. Since its inception 25 years ago, it has produced returns of 3% annually. Performance: 11.23% (one year) and 3.05% (10 years).

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