Wisdom for 2024: Answers to Your Questions
What happened last week?
- The S&P 500 gained 0.77%
- The Dow Jones rose 2.42%
- The Nasdaq advanced 0.38%
This week investors will zero in on Friday’s US jobs data. The economic community expects 158K jobs created in November alongside an unchanged 3.9% unemployment rate and average hourly earnings growth of 4.0% y/y.
This will be the last jobs report before the Fed meets on December 12–13 where the central bank is expected to leave rates unchanged.
3 Things to Know
Will a recession in 2024 spoil the economy and markets?
Despite a rapid and painful rise in interest rates and a significant tightening of financial conditions, we think a “standard US recession” in unlikely in ’24. In fact, we expect the US and world economy to slow in 2024 before strengthening substantially in 2025.
For 2024, we see employment growth slowing significantly even as industrial production and business sales recover. Rising output is not typical of a business cycle recession.
Nor are rising business profits after a year of decline. So, while there may be a “labor recession” in 2024, we believe moderating interest rates and increases in corporate profitability will lead to higher earnings and drive gains for equity markets.
Will sticky inflation keep the Fed from cutting interest rates?
Inflation was fueled by excessive fiscal and monetary stimulus designed to bridge the US and global economies across the pandemic, by dislocations in supply/demand relationships and by geopolitical issues, including the war in Ukraine.
The Fed’s actions to support the economy were its most accommodative actions since WW2. Therefore, when the Fed started hiking rates, it was not raising them from a neutral rate.
The Fed was, itself, a source of inflation. The real Fed funds rate (Fed Funds Target minus year-to-year Headline CPI) was an astonishing -8.3% in March 2022. That was 2x more accommodative than the Fed was during the ’08–09 financial crisis.
The current inflation rate in the US is 3.2% as of October. That is a 5.7% drop in just 16 months. Therefore, it is hard to argue that inflation is sticky. In fact, finished producer prices (-0.4%) and import prices (-2.0%) have actually fallen year-over-year.
Core prices excluding shelter are up just 2% year-over-year. And shelter, the greatest laggard in the CPI, is coming down sharply as home price appreciation ends. Lagging indicators, like shelter, roll out of the CPI over 12 months.
We all recognize that if inflation remained at 2022 levels the Fed would not cut rates. But many indicators suggest that inflation will be at 2.5% by year-end 2024.
What’s the right amount of cash to hold?
For many investors, the allure of 5% overnight cash rates remains high. After all, if you can get 5% in money market funds, why not take the interest and run?
With the Fed holding their short-term rates at peak levels for now, this may seem a conservative strategy. For some, cash is being held aside to make opportunistic future investments.
For others, cash is “safe money” for emergencies. But both rationales may lead to contradictory outcomes.
As outlined in our forthcoming Wealth Outlook 2024, the right amount of cash for portfolio purposes is low, just 1% of our recommended asset allocation.
- The first is that the Fed is unlikely to keep rates at these levels. Assuming the Fed believes inflation is under control, it typically begins to reduce short-term rates as employment growth stalls.
- Second, by moving from cash to intermediate bonds, the risk-return leans in favor of investors. Bond buyers today may lose a bit on a mark-to-market basis if rates rise for a while, but the potential gains from bond ownership are more favorable today. While an investor earns a coupon of more than 4%, they may also see appreciation in their bond portfolios. On average over the past 30 years, a 5–10-year duration Treasury has gained 10% and 19% over a 1- and 2-year period, respectively, after the Fed’s last rate hike.
- Finally, as we reset our strategic return estimates, cash remains the poorest long-term performer. Cash yields rarely exceed the inflation rate and often dip below it.
So, in addition to losing real value as a unit of currency, the cash not invested in markets in broadly diversified portfolios is associated with a significant opportunity cost, as well.
See our weekly CIO Strategy Bulletin for more details