Our 2024 Fearless Forecast: Can the Fed Deliver a Soft Landing?

Executive Summary: Our outlook for 2024 is bullish for both stocks and bonds. While we expect modest equity returns in 2024 compared to last year, we see the S&P 500 rising 8%-12% this year, as falling inflation, modest economic growth, above-average profit growth, lower interest rates, and the now famous “Powell Pivot” breathes life into the prospects of a soft-landing.

We see the market making a new high early in the year but expect that the bulk of equity returns this year will be backloaded and occur post-election. Clients should be prepared for heightened volatility during the first part of the year as the soft-landing scenario will be swiftly questioned on any sign of economic weakness. This will be particularly true if the Federal Reserve hints at deferring rate cuts to mid-year or beyond. Heightened volatility is a nice way of saying that the market could see as much as a 10%-15% correction this year, given stocks appear to be priced for perfection presently. Nonetheless, corrections are healthy and common, even in a bull market.

Moreover, as we move into mid-year, investors will turn their attention to the Presidential Election in November, suggesting choppy or sideways trading action over the summer and into the fall. With the election outcome known, investors should anticipate the typical election year rally in the 4^th quarter.

As always, our advice is to view your investment portfolio through an economic lens and not a political lens and to look past the near-term noise and news headlines that are prominent during an election year. In the end, we expect the market to climb a Wall of Worry on its way to back-to-back gains in 2024. Please read on as we take a quick look back on last year and detail why we are optimistic on the year ahead.

2023: The Year That Wasn’t

2023 will go down as “The year that wasn’t”. By that, we mean that 2023 was anything but what was expected. There was no recession as predicted by 61% of economists in January 2023¹. There was no banking sector meltdown as feared early in the year as the Federal Reserve stepped in to rescue Silicon Valley Bank. Goods inflation fell dramatically faster than expected, while service inflation surprisingly nudged lower, not higher. Unemployment didn’t climb to 4.8% as thought and instead held steady near an all-time low. Finally, the economy grew just over 3% for the year, nowhere near the anemic growth forecast. To boot, the S&P 500 gained 26%, far exceeding the consensus forecast of only 5%.

To be sure, broadly diversified investors with exposure to midcap, small cap, international and emerging markets were somewhat left behind as the Magnificent 7 (Amazon, Alphabet, Apple, Meta, Microsoft, NVIDIA & Tesla), surged 111% and accounted for the lion share of the gains, as the remaining 493 stocks in the S&P 500 gained only 12%².

At the Fed’s November 1^st press conference, Federal Reserve Chair Jerome Powell lit a fire under stock and bond markets when the heretofore “hawkish” Powell surprised investors by signaling that the Fed was likely done raising short term rates. Moreover, they indicated that they were turning their attention to the possibility of three rate cuts in 2024.

This abrupt change in the Fed’s view is now famously known as the “Powell Pivot”. What followed was a multiweek win streak for stocks, the longest stretch in years, as the S&P 500 rallied nearly 13%. Effectively, 50% of the gain in the S&P 500 came in November and December alone. After peaking at nearly 5% in late October, the yield on the 10-year Treasury bond dropped from 4.88% on October 31^st to 3.86% by year end, to end the year unchanged. Suffice to say, both stock and bond investors were taken for a wild ride last year.  

What’s in Store for 2024?

Below, we share our outlook on the themes influencing the economy and thus the financial markets in 2024:

1. INFLATION: Inflation continues to approach, if not reach, the Fed’s 2% target. The direction of inflation is what matters, and it’s clear that the inputs (COVID related supply-chain challenges and massive fiscal and monetary stimulus) that led to a 40-year high in inflation are in our rearview mirror. The CPI peaked in June 2022, with a year-over-year (YOY) increase of 9.1%. The Bureau of Labor Statistics (BLS) reported recently that the December 2023 YOY increase in CPI had fallen to 3.4%; down substantially from 9.1%, just 18 months earlier³. On Friday, the Commerce Department reported that the personal consumption expenditures (PCE) price index, the Fed’s preferred inflation gauge, increased 1.7% in Q4 of last year. This compares favorably to the 2.6% increase in core prices seen in the preceding quarter and is decidedly below the 5.4% YOY increase seen at the end of 2022. Equally important, the three-and six-month annualized rates of core inflation were 1.5% and 1.9% in December⁴.

2. INTEREST RATES: The Federal Reserve will indeed lower short-term interest rates this year (we forecast 3-4) but perhaps not as soon as, or as much as, investors might prefer. Given that inflation has peaked and is decidedly approaching the Fed’s target, it’s not surprising that investors reacted so positively when the Fed signaled it was eyeing rate cuts in 2024. Famed investor, Marty Zweig was best known for saying “Don’t Fight the Fed”. This axiom proved correct in 2022 as the Fed raised interest rates aggressively and the S&P 500 fell 18%. It proved correct again in 2023 when the Fed signaled rate cuts were coming, and the S&P 500 gained 13% in just two (2) months. Barring a hard-landing for the economy, which is currently not a high-probability outcome, investors will be wise to not fight the Fed in 2024. Falling inflation begets falling interest rates, particularly mortgage rates, which is a key factor given the housing’s share of economic output. The average 30-year fixed rate mortgage recently fell to 6.6%, the lowest level since May of last year, and is down significantly from the 2023 peak of 7.79%⁵.

3. CORPORATE PROFITS & VALUATIONS: According to J.P. Morgan, consensus analyst expectations for corporate earnings in 2024, is for earnings to grow 12% and to reach $243⁶. Using the January 26^th closing price for the S&P 500 of 4,907 and $243 in earnings, the S&P 500 trades at a P/E ratio of 20x this year’s earnings, well-above the 30-year median P/E of 16.6 and one (1) standard deviation above the median. Accordingly, stocks are somewhat overvalued at present, suggesting limited upside over the near term. In 2022, when earnings fell -1%, the P/E for the S&P 500 hit a low of 17x in October of that year, near the 30-year median. If the S&P 500 were to trade at 17 times 2024’s earnings estimate of $243, that would imply a price level of 4,131. This is coincidentally (or not) roughly 15% from the current level of 4,907 for the S&P 500.

4. CONSUMER SENTIMENT & CONSUMER SPENDING: Consumer sentiment surged 9.1% in January according to the University of Michigan survey, the biggest one month advance since 2005 and the highest overall level since July 2021. Sentiment has risen 29% over the course of the last two months, the largest such increase since 1991. Meanwhile year-ahead inflation expectations fell 2.9% on the heels of a dramatic decline in December and personal income was up 3.15% in December compared to a year ago, up significantly from the -1.28% annual rate registered in June of 2022⁷. Improving sentiment, rising personal incomes and consumer spending bode well for economic growth this year.

5. GROSS DOMESTIC PRODUCTION (GDP): According to the Bureau of Economic Analysis (BEA), the initial estimate for year-over-year (YOY) real GDP growth in Q4 of 2023 was 3.3%. This followed YOY growth of 4.9%in Q3. Across all four (4) quarters, real GDP grew 3.1%⁸. Our view for 2024 is that economic growth will land in the 2.0% – 2.5% range, as corporations and consumers continue to feel the lagging but temporary impact of high interest rates. For reference, 2% is effectively the long-run growth rate for the US economy. We are watching carefully several key economic inputs such as the Leading Economic Indicators (LEI), which has gradually fallen lower for the past twenty months. Another input is the yield curve, which remains inverted. An inverted yield curve occurs with short-term rates are higher the long-term rates and historically precedes a recession. Will this time be different?

6. SOFT LANDING: For much of 2023, the soft-landing thesis was challenged as the Fed steadfastly held to its commitment to put the inflation genie back in the bottle, keeping the threat of a recession front and center for investors, who on the heels of an 18% decline for the S&P 500 in 2022, were rightfully skittish. As has been the case for the past two (2) years, the market will continue to debate the hard landing versus the soft-landing outcome. Given that the Fed has signaled its intention to lower rates this year and its propensity to cut rates when the economy softens, we’re firmly in the soft-landing camp. Having said that, investors should brace themselves for hard landing rhetoric in the first part of the year as the economic data ebbs and flows and recession fears resurface.

7. THE PRESIDENTIAL ELECTION: The 2024 Election will provide plenty of theater for investors and every opportunity to fear the worst if your party and/or your candidate loses, regardless of your political affiliation. The outcome will not likely alter the fundamental course for the economy or the stock market in 2024 and perhaps not in 2025 but that bears watching. The simple truth is that the President is one person, and that person is subject to Congressional and Judicial checks and balances, against the backdrop of a slow-moving $26 trillion US economy. Sadly, the political landscape in our country is so divisive at present that Americans will continue to be (for better or worse) subjected to Congressional gridlock. This “balance of power” means the status quo will likely remain in place, until it doesn’t. As we alluded at the start of our Fearless Forecast, investors should not let a political headache turn into a portfolio heart break.