2024 Economic and Market Outlook
Analysis, insights, and expectations from members of Commonwealth's Investment Management and Research team
Executive Summary
Despite recession fears, 2023 was a surprisingly robust year for the economy. We expect the positive trends to continue in the new year, which should support continued financial market performance. But that doesn’t mean the road ahead will be smooth.
Read on to learn what we see in the data and how we think it will contribute to our expectations for 2024.
By the Numbers: A Trail Map for Year-End 2024
Inflation | GDP Growth | Fed Funds Rate | U.S. Treasury | S&P 500 |
| 2.5%–3% | 3.75% | 4.75%–5% | 4%–4.5% | 4,700–4,800 |
Source: Commonwealth, as of December 14, 2023
Video: Inflation Talk
Transcript
So, we’ve talked a lot about inflation. And we’ve all seen the data; it’s going up, it’s coming down, and maybe it’s going to go up again. What do you guys say?
Maybe this is one area where we differ in our views, where I do think over the long term that the Fed is going to achieve its 2% mandate of inflation, especially because when you break it down—and this is something we've talked about in a number of pieces that we've put out and on our various calls—is that roughly one-third of overall inflation is shelter related. And it’s the one component that continues to slide month after month, especially now, where we’ve seen mortgage rates go up to 7.5–8%. That has a significant impact on the overall level of demand.
Now, the one piece that also has to balance out there is the supply side of the equation, and we’re continuing to see new home inventory come online, which will help balance out prices a little bit. But if that measure—the shelter component of CPI—continues to slide over the course of the next year, I think we do continue to move towards the Fed’s 2% mandate of inflation. Not, perhaps not by the middle of 2024, but I think we are going to get there.
But, see, you’re moving the goalposts here. You said, “Oh, no, this is doable, and this is sustainable.” Once you give your forecast, you’re generally done. Give them a number; give them a date; never give them both. Right?
You also said, “Over the long term, it’s achievable.” But is that a short-term achieving of the goal? Because housing and rent doesn’t stay down, right? Because I’ve always been . . . I have agreed with you until we got to about this point—and I’m not saying now I’ve changed my mind. I always thought the last 100–150 basis points was going to be the hardest part of the Fed’s job. Because it has a big impact.
Yeah, and you especially have the fishhook now going on with energy prices, and energy prices correlate very closely to food prices, as well as other components of the economy. So, I guess I would caveat my comments by saying, if the shelter piece continues to slide, the other areas, like energy, have to moderate to some degree as well. It’s probably fair.
Yeah, and one of the things, you know, it’s always important when you’re talking about monetary policy and how it drives inflation, is remembering the fact that monetary policy works with a lag. Right, so it takes time for the effects of higher rates to bleed into the overall economy. And we’ve seen that in a number of places, but one of the places where it actually can have a pretty quick impact is in housing, right, to the point that you made about interest rates affecting mortgage rates. Well, the impact from those higher rates then takes time to feed into the data, right. So, while it can slow the pace of housing sales, which we've absolutely seen over the past couple years, prices tend to catch up with a lag. So, based on the sales data we’ve seen and the price data we've seen, I do expect to see continued improvement on the shelter side, which to your point, Pete, should help on the overall inflation side.
And generally, what we’ve seen from the data is that there’s a lag of about 12 to 18 months with changes in home prices, and those changes being reflected in the shelter component of CPI. So, you know, we’ll see what occurs over the next 6 to 12 months on that front.
What’s interesting about that is we're talking about the next 6 to 12 months. I see us moving down to maybe 3—I’d be okay with 3, maybe a little bit below that. You know, longer term, though, we have the disinflationary effects of AI potentially, and better productivity growth, which seems to be happening. But then you look at higher . . . you look at, you’re not going to see the globalization benefit we got over the past 30 years. You’re not going to see the very low real wage growth, which we’ve seen over the past 30 years; a bunch of disinflationary effects over the next decade are not going to be there to the extent that they were for the past 20. So, I’m more in the 3 to 4 over time. We may touch to 2 in the short term, although I doubt it. But I still think we’re in the 3 to 4 over time.
Absolutely. That’s a very valid point, especially when you consider the onshoring, or the reshoring, of a lot of manufacturing activity, which, to your point, you know, we don’t benefit from the globalization and the lower cost of labor abroad if a lot of those industries are being brought back on shore.
With that being said, I do think it’s also important to remember, the Fed has signaled that they don’t expect to get inflation down to 2% next year, right. Based on their most recent projections, they don’t expect to see their primary measure of inflation get to their 2% target till around the end of 2026. And that outlook, with a slow improvement against inflation, I think should be remembered, right? It’s not necessarily going to be a sharp hook up and then a sharp hook right back down. It’s a sharp hook up and then takes some time to get back to what’s a more normal level. And over the course of that normalization process, the Fed has also signaled, through their dot plots, that they’re open to cutting the federal funds rate even before inflation reaches their target, right. They just want to see continued progress in the right direction, and they’d be willing to adjust monetary policy accordingly. Right, because we’re at very restrictive levels right now with the top federal funds rates at 550. Well, the argument there is you could still be restrictive at 5, or 4.5, or even 4% on a federal funds rate, with inflation still running above the 2% target.
But I think that’s what the market has to get used to is higher for longer. Right, I think you even saw it last week when long rates started to come down, risk assets went and completely rallied unlike anything that we’ve seen so far this year. I think if there’s one thing that could set us up for disappointment next year is if the Fed doesn’t cut, but there's an expectation that they will cut and be more aggressive, that risk assets could sell off. So, add that to the list of risk factors for 2024.
The key part of that is that people have to get used to this, right. And this is kind of where the . . . what your baseline is, right? And as the guy around the table with all the gray hairs, 3% inflation and 5–5.5% on the 10-year is not bad, right? Like I lived through that; people had jobs, the economy grew, they bought houses, the equity market went up. Right? So, it’s this . . . the market’s hung up on when the Fed’s going to cut rates. Where my view is, if we can just figure out what normal is, you can make investment decisions based off “normal” that can be quite additive to portfolios, but it’s the short term, you know, to Brian’s point, the 10-year went from 500 to 450. And the S&P took off. It’s just clouding the decision-making process.
And I think that’s exactly right, Chris. In fact, at our National Conference that’s what I talked about. You know, what’s normal? What should interest rates be? You know, and the short version is, they should be inflation plus a risk premium. Historically, the inflation rate has been 2 to 4—call it 3, call it 4; risk premium has been 2 to 4. So, rates have almost always traded between 4 and 8. So, now we’re at about 5; that’s still at the lower end of the range, but inflation is also kind of low. So, you know, the question as I see it is not so much “when’s the Fed going to cut?” It’s, “why would the Fed cut?” And I don’t think we see a compelling reason, until we see employment fall off a cliff. And with the market the way it is, as you say, Pete, I’m not sure we see that, so higher for longer makes a lot of sense to me.
I was asked last week, if we accept that rates are higher for longer, what does history tell you about what the appropriate asset allocation should be for that? And as I started thinking about it, my answer was—I don’t think that interest rate part of it is the key determinant, right? Because if you go back to what you just said, the mid to late ’90s and the dot-com boom, rates were over 4%. The BRIC-led commodity boom in ’05–’06—rates were over 4%. Entirely different approaches to portfolio construction in the same rate environment. So, I think, ultimately, once we accept it, other factors start to drive investment decisions and where you want to be positioned in portfolios.
And that’s actually, I think, a really good insight. It’s not the absolute level; it's the change. You know, if, in fact, rates are going to be stable more or less where they are right now, then rates come off the table as a factor driving market decision-making. That’s a wrap. All right, guys. Good job, guys. Thank you. Thanks, that was fun.
Certain sections of this commentary contain forward-looking statements as of the date published that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Opinions are subject to change without notice. This communication should not be construed as investment advice, nor as a solicitation or recommendation to buy or sell any security or investment product.
Featuring members of Commonwealth's Investment Management and Research team: Brad McMillan, Brian Price, Peter Essele, Sam Millette, and Chris Fasciano
2023 will be remembered for the recession that never happened.
U.S. Economy: Sustaining Our Upward Momentum
In December 2022, many economists seemed convinced the economic drivers were grinding to a halt. An unwinding of the Fed’s balance sheet, higher interest rates, and an inverted yield curve seemed like the perfect storm that would rain on the economic parade.
But over the past 12 months, the economy has done anything but slow down. We’ve seen job growth, increased consumer spending, and higher gross domestic product (GDP) growth than expected. Compared to the pre-pandemic decade, it was an exceptionally robust year.
Will those trends continue in 2024? Click the tabs below to learn how the four components of the economy factor into our outlook.
American consumers are the grease in the economic engine. Their ability and willingness to spend are pivotal to economic growth, especially in the near term. Low unemployment and higher salaries are creating a just-right scenario for this to play out.
Employment and wage growth. Strong labor demand has led to some of the largest wage gains we’ve seen in decades. Wage growth will likely stay elevated given the significant imbalance of job openings to unemployed individuals.
Spending and saving. With more money in their pockets, consumers are spending more. But they’re also saving less. Credit card debt as a percentage of the personal saving rate has increased at the fastest pace since 2007, according to Standard & Poor’s. This should translate into near-term growth since roughly two-thirds of GDP is related to consumption. It bears watching over the long term, though, as carrying too much debt can be detrimental to long-term growth.
What are consumers spending their money on? After several years of one-sided spending, the path ahead is starting to even out. During the early days of the pandemic, consumer-related goods were the focus. Demand, hampered by supply chain issues, drove up prices.
As the economy reopened, Americans’ spending habits shifted to the service sector, focusing on areas like travel, sporting events, and dining. Prices on goods and services reflected that change.
In 2024, we believe we’ll see goods and services spending, which have historically moved in lockstep, come back into balance.
Risks to this outlook. A notable breakdown in consumer confidence—which could result from an uptick in unemployment, an increase in inflation, or more rate hikes—would likely manifest in slower spending, presenting a headwind to growth.
Confidence has been declining in recent months, but the Conference Board Consumer Confidence Present Situation Index remains in a healthy range as of the end of October. We believe this should support the consumer segment of the economy heading into 2024.
Keeping the Bears at Bay
Many economists were solidly in the recession camp in the fourth quarter of 2022. Our outlook differed to a large extent, and that’s the case this time around, too. We expect a Goldilocks economy—one that offers full employment, economic stability, and moderating inflation. This foundation will offer an ideal state for the financial markets and keep the bears at bay.
Inflation and Rates: Leveling Off at Last
Inflation and interest rates have been two major drivers of market performance over the past two years, and they are expected to remain important in 2024.
In 2021, global supply chain pressures, labor and material shortages, and loose monetary and fiscal policy caused inflation to spike. Thus began the Fed’s rate-hiking cycle to combat inflationary pressures in the economy. The fed funds rate increased from a range of 0 percent to 0.25 percent in 2021 to a range of 5.25 percent to 5.50 percent by the end of November 2023. And the effects of those hikes are starting to show up.
Growth in the Consumer Price Index (CPI), a key measure of price changes over time, moderated in October, coming in at 3.2 percent. While prices for food, energy, and commodities have declined, service inflation remains high partly due to housing costs. And because housing costs respond with a lag to higher rates, this could slow headline progress in the Fed’s pursuit of its 2 percent target.
Higher for Longer
As a result of that lag, we expect interest rates to remain elevated. Markets project four rate cuts of 25 basis points (0.25 percent) in 2024. We believe the Fed may make one or two moderate cuts, bringing the federal funds rate to 4.75 percent to 5 percent by year-end. Medium- and longer-term rates should be rangebound, with the potential for a modest fall in yields if the Fed signals an appetite to cut rates.
Financial Markets: Which Path Will They Take?
Click to expand the sections below.
Throughout 2023, the mainstream media has focused on the new Magnificent Seven—Alphabet, Amazon, Apple, Meta Platforms, Microsoft, Nvidia, and Tesla. These names have driven the S&P 500 up 20.80 percent almost singlehandedly. That’s great for large-cap growth investors. But the rest of the market tells a different story.
It has been taking its cues from interest rates. And those have gone in only one direction: up.
That trajectory has weighed on performance. Year-to-date, the S&P 500 Equal Weight Index, which includes the same companies as the widely used S&P 500 but in equal allocations, is up only 6.56 percent after a strong November rally. The small-cap Russell 2000 Index is up 4.20 percent over the same period. This illustrates how much the Magnificent Seven are holding up the market.
At the same time, we’ve seen a stealth equity rally overseas. The MSCI ACWI ex-US Index has risen more than 10 percent since the beginning of 2023 after a lengthy period of underperforming U.S. markets.
Where does this leave us?
Based on valuations, the more attractive asset classes are those that have underperformed over the last few years: value, small-cap, and international. But there are clouds on the fundamental horizon for these areas:
Value companies tend to be cyclical and need an expanding economy to grow.
Small-cap companies tend to carry more floating-rate debt than their larger peers, and refinancing at higher rates will present earnings headwinds.
International economies continue to battle inflation and the impact of geopolitical confrontations on energy and food supply.
So, while large-cap growth is more expensive compared with other asset classes and historical valuations, we believe it has a more solid foundation, especially when you factor in the outlook for artificial intelligence, which is revolutionizing the technology sector.
Currently, S&P 500 earnings for 2023 show little, if any, growth compared to 2022. And while consensus estimates for 2024 suggest double-digit growth, analysts tend to be more optimistic heading into the start of a new year. The reality is likely to settle somewhere in the mid-single-digit range. Within the international space, emerging markets are expected to have strong double-digit earnings growth, which would offset a slower growth outlook for Europe and Japan.
As equity markets work through prevailing concerns and investors become more comfortable with the new normal of higher-for-longer rates, we expect the S&P 500 to end 2024 between 4,700 and 4,800, with the MSCI ACWI ex-US Index around 315–320, an increase of approximately 5 percent from its level at the end of November.
Politics and Policy: Will Washington Push Us Off Track?
The current battles in Washington are rooted in politics. Next year, they will be based on economics—generating a potential headwind.
Political Risks
Emerging political risks should be relatively low.
ElectionsThe presidential election will include ads aplenty around the existing administration and the challengers. Investors may have trouble keeping their cool in this heated environment. | Divided GovernmentA government shutdown is possible, but neither party seems to want it. Some of the more obstructionist politicians have even voted it down, and that’s progress. |
Policy Risks
In 2024, the deficit will again take center stage.
Deficit and DebtPersistently high rates could slow the economy, resulting in lower tax receipts and an increase in the interest owed on federal debt. The uncertainty surrounding higher rates will also increase economic and market risks. | Taxes and Government SpendingAs key components of the economy, taxes and government spending will provide fodder for the November election and grab the headlines. |
Geopolitical Risks: Navigating Turbulent Waters
Geopolitical risks are dominating the headlines. Market expectations are low, which means there could be room for upside.
Ukraine war. Here, one of the major economic effects has been Ukraine’s inability to export food—a constraint that’s being lifted as Russia is forced out of the Black Sea. This problem will continue but looks to become less extreme.
Israel-Hamas war. It appears that most regional players don’t want a wider war in the Middle East, which should limit the global economic damage. As the situation evolves in 2024, it may become less threatening to the world as a whole.
Financial crisis in China. Although Chinese real estate companies continue to get into deeper financial trouble, the Chinese government has the ability and the will to contain the problem, which will limit the global effects.
Deglobalization. This is a long-term trend, and it's been underway for some time. Companies are figuring out how to make it work. The disruptions, while real, are also likely to be less than currently expected.
The real takeaway for 2024 is that, from a geopolitical point of view, it is likely to be very much like 2023. While we need to be aware of the risks, we also need to remember that markets price around risk, and they can rise even in the face of it.
Contributors
Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. All indices are unmanaged and are not available for direct investment by the public. Diversification does not assure a profit or protect against loss in declining markets. Bonds are subject to availability and market conditions; some have call features that may affect income. Bond prices and yields are inversely related: when the price goes up, the yield goes down, and vice versa. Market risk is a consideration if sold or redeemed before maturity.
The S&P 500 is based on the average performance of the 500 industrial stocks monitored by Standard & Poor’s. Emerging market investments involve higher risks than investments from developed countries, as well as increased risks due to differences in accounting methods, foreign taxation, political instability, and currency fluctuation. The MSCI EAFE Index is a float-adjusted market capitalization index designed to measure developed market equity performance, excluding the U.S. and Canada. The MSCI Emerging Markets Index is a market capitalization-weighted index composed of companies representative of the market structure of 26 emerging market countries in Europe, Latin America, and the Pacific Basin. It excludes closed markets and those shares in otherwise free markets that are not purchasable by foreigners. The MSCI ACWI ex USA is a free float-adjusted market capitalization-weighted index that is designed to measure the equity market performance of developed and emerging markets. It does not include the United States.
Investments are subject to risk, including the loss of principal. Past performance is no guarantee of future results.
This material is intended for informational/educational purposes only and should not be construed as investment advice, a solicitation, or a recommendation to buy or sell any security or investment product.
