As we enter 2024, here are the predominant questions related to the economy and capital markets:

• Will the economy avoid recession as presently expected?
• Will the Fed cut interest rates as presently expected?
• Will corporate earnings grow 10% as presently expected?
• Will equity market participation broaden away from the “Magnificent 7”?

We could list more, but why clutter the discussion with unnecessary diversions into subtext? The above four are the most important ones and the answers to these questions over the coming months will determine how the capital markets perform and how investor portfolios perform. So, let’s focus on them.

Will the economy avoid recession?

Firstly, before directly answering this first question, it is important to point out the inherent contradiction between the two opposing views that are held jointly and simultaneously in the form of questions 1 and 2 above. We feel strongly that either the economy avoids recession OR the Fed cuts rate. There is little to no chance both these things occur. Only one will. Nonetheless, markets presently expect both to occur, judging from stock and bond returns in the fourth quarter. Bond markets are pricing several rate cuts. Stock markets seem to be forecasting recession avoidance. Only one of these markets will be right.

If the economy avoids recession, we think there is almost zero chance the Fed will cut rates. Why would the Fed cut rates if the economy is growing? The Fed will only cut rates if the economy is going into recession or in recession. As of now, there is no threat of a recession in the data. Consumption is strong. Job creation and employment is strong. GDP remains strong. There is nothing in the data right now foretelling recession except for the stubbornly inverted yield curve. The inverted yield curve does suggest a recession is looming, but this signal has been flashing for nearly two years. Maybe it is different this time.

Will the Fed cut interest rates?

The current consensus calls for three 25 basis point rate cuts in 2024 beginning in March. Our view? There is almost no chance rates will be cut in March. We won’t likely see any material shift in the macro picture by March which would lead to a justifiable rate cut in March. Further, unless a sharp reversal in the economy occurs, we don’t see 75 basis cuts in the year as currently implied in bond prices. Furthermore, we think the prognostications by some market commentators calling for 175 basis points or more are patently absurd. The economy is holding up fine at this stage. As of now, it appears the level of interest rates are being handled well in the real estate and banking sectors while the economy continues to grow. If the economy keeps chugging along as it is presently, the case for no rate cuts in 2024 is strong.

 

Will corporate earnings grow 10%?

The short answer is: probably not. But earnings will probably grow 6-8%. If this happens, the stock market can post a modest 6-8% return. P/E levels extended again in the fourth quarter. Thus, stocks are priced richly, especially Mega Cap tech stocks. Thus, we don’t think markets can increase on multiple expansion, particularly considering the level of interest rates. Conservatively, planning for a 6% earnings growth environment and a 6% return environment for stocks seems prudent. Anything better will be a welcome surprise.

Will equity market participation broaden?

Almost certainly they will. Stock markets broadened in the fourth quarter of 2023 after a period of mega cap dominance. We think small and midcaps have a very good chance of outperforming large cap stocks in 2024 because their valuation levels are much more reasonable after underperforming large cap stocks for several years. If we are right, this will materially benefit the strategies we manage on behalf of our clients.

Looking ahead

Forecasting is always a tricky business, and it is easy to be wrong. No one has a crystal ball or a monopoly on truth. We are mindful of these things. An old colleague once described portfolio diversification as “admitting our ignorance and prospering in spite of it.” We think this is an apt description of our approach. We invest in a lot of assets on behalf of our clients. In any one discreet time period, some of them will perform well and some of them will lag. We will hold some of them and sell some of them (both kind, winners and losers). The moral of the story: no one is perfect. As we step through each day of this new year, we will collect information about the economy, the markets, and our holdings and make our best judgement on the data available to us. We thank you for the trust you place in us. Call or e-mail any time.