January 8th, 2024
Happy New Year! I hope it’s off to a fantastic start.
As the year begins, I reflect on the many – known – variables that will affect the markets in 2024.
Another year of increasingly tense geopolitics, a presidential election year where our two front running candidates have the highest disapproval rating in US history, and the economic hangover from a multi-year inflationary environment. Although inflation is now in a healthy range, its consequence has left us with a higher cost of living, more debt than ever before and dwindling savings for most Americans.
Having said that, equity market investors seem to be overwhelmingly upbeat. Finishing the 2023 calendar year with a bang, the market took off like a rocket ship following the Fed’s December meeting where Jarome Powell, Fed Chair, signaled three rate cuts in 2024. Moreover, a healthy economy with near full employment, real wages climbing, inflation back in the Fed’s desired range and solid GDP growth have given the market much to be positive about.
So, what’s in store for 2024?
Setting aside the many known factors that will inevitably affect markets and the economy, I believe the key driver of equity market growth (or lack thereof) in 2024 will reside with the Fed’s stance on, and changes made to: interest rates.
As you know, to combat inflation, the Fed has been nudging rates higher since March 2022, by implementing 11 successive rate hikes that took the Federal Funds rate from 0-0.25% to 5.0-5.25%. The rate hikes worked quite well despite the terror of many market pundits. The chart below shows Core PCE inflation – the Federal Reserve’s preferred inflationary indicator – measured as an annualized figure using the last 12-months of data (dark blue line), 6-months of data (brown line), and 3-months of data (light blue line). Of note is the 6-month annualized measure of Core PCE at just 1.9%. Showing that for the last half of 2023, inflation undercut the Fed’s target rate of 2%. If we get just a few more monthly readings of 0.1% or lower, we will quickly see the annual rate of Core PCE fall below 2% as the ‘hotter’ monthly readings from earlier in the year fall out of the dataset. The Fed has been looking for consistent monthly improvement and the 3 & 6-month trends certainly meet that threshold.
Although signaling that rate cuts may emerge in 2024, the Fed has also been adamant that rate cuts aren’t imminent and this will be an action taken later in the year. However, the market believes the Fed will cut as early as March 2024. Why? Ultimately, the Fed risks playing a game of chicken with a potential recession if it waits too long – the market believes cuts will be required to avoid a recessionary effect prior to June. As of now, from the data I’m seeing, a recession appears to be a remote possibility in the first half of 2024 given our low unemployment rate. But if the Fed is misreading the strength of the US consumer to keep spending and providing economic growth, things could quickly deteriorate and the Fed could end up causing the recession it has been fortunate enough to avoid thus far. On the other hand, too aggressive of rate cuts could rekindle the inflationary fires and limit the Fed’s ability to affect positive economic change if further economic challenges do appear.
I foresee rates remaining higher, longer overall. That said, I also foresee small rate cuts sooner than later. Nominal rate cuts will have positive cascading effects on the market and produce further confidence for consumers and business owners alike. Keeping rates on the ‘higher’ side will provide the Fed with more tools if, and when, an actual recession does appear. Rather than opening the flood gates and starting a new inflationary cycle, I see the Fed attempting to inspire a year of balance for the economy and equity markets. Marginal gains for large-caps, larger gains for small to mid-capitalization companies, and a year where folks lock in long-term bonds which capture the high coupon rates they currently provide.
I hope 2024 provides us all an opportunity to remember how fortunate we are to live in America. Where we do have the freedom to seek out opportunities and create an abundant life ourselves, and our families.
As always, we will continue investing in companies who are mindful of their effects on the world – socially, environmentally, and economically – and who create intrinsic value for society.
And now, your Monthly Market & Economic Update by the numbers.
Warmly,
Mark S Sauer
Market Update
Global Equities: 2024 was volatile but December bared much fruit for those who held on tight. The S&P 500 gained 23.75% over the 12-month period, the Dow Jones Industrial Average added 13.7%, but the big winner for the year was the Nasdaq 100 up a whopping 53.05%. Developed International Stocks were up 12.97% and Emerging Markets unperformed everything but still up 4.1% for the year.
Economic Update
Was that a Pivot? The Fed and the market have been playing chicken over interest rate projections, with the Fed trying to convince investors that rates will remain elevated with additional possible hikes. The investing public has not bought the story, however, December’s Fed meeting looked like investors were correct in calling the Fed’s bluff. The Fed tweaked its policy language in an indication that rate hikes are all but complete. The Fed’s “dot plot” interest rate forecast also received a dovish revision, with the consensus view showing 75 basis points of cuts by year end. The timing of the rate cuts is still in question, with Fed commentary suggesting third quarter 2024 but the market expecting March with an 85% probability.
Charts of the Month
Mega-Caps Vs. Small Caps in 2024?
Our first chart shows 2023’s returns for the S&P 500 (ES1!, Blue line), the Nasdaq 100 (NQ1!, Orange line) and the Russell 2000 Small Cap Index (IWM, Teal line). The Nasdaq has been the clear winner, thanks to the “Magnificent Seven” mega caps. IWM has been accelerating in the fourth quarter, however, as investors begin to rotate out of mega caps and into small caps due to their historically cheap valuations and potential to outperform during a period of falling interest rates.
10-Year Treasury Yeild
Our final chart shows the yield on the 10-Year US Treasury Note over the past year. The 10-Year yield spent the entirety of 2023 ascending as the Fed continued rate hikes, ultimately touching 5% in October before a shift in Fed policy at the November meeting. Since then, yields have been in free-fall as investors rushed to lock in the favorable rates before they vanish. Rates found some support in recent days with the Fed timeline for cuts in question, but with hikes near certainly complete, the downward pressure should remain in 2024.
